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[House Prints 109-E]
[From the U.S. Government Publishing Office]

109th Congress                                                Committee
                            COMMITTEE PRINT                 
 1st Session                                                Print 109-E
_______________________________________________________________________

                                     

 
        WASTE, FRAUD, AND ABUSE CONCERNS WITH THE E-RATE PROGRAM

                               __________

                             A STAFF REPORT

                             ADOPTED BY THE

              SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

                                 OF THE

                    COMMITTEE ON ENERGY AND COMMERCE

                     U.S. HOUSE OF REPRESENTATIVES

                             109th CONGRESS

                                     

                                     
[GRAPHIC] [TIFF OMITTED] TONGRESS.#13

                             November 2005

                    U.S. GOVERNMENT PRINTING OFFICE
24-466                      WASHINGTON : 2005
_____________________________________________________________________________
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?

                    COMMITTEE ON ENERGY AND COMMERCE

                      JOE BARTON, Texas, Chairman

RALPH M. HALL, Texas                 JOHN D. DINGELL, Michigan
MICHAEL BILIRAKIS, Florida             Ranking Member
  Vice Chairman                      HENRY A. WAXMAN, California
FRED UPTON, Michigan                 EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida               RICK BOUCHER, Virginia
PAUL E. GILLMOR, Ohio                EDOLPHUS TOWNS, New York
NATHAN DEAL, Georgia                 FRANK PALLONE, Jr., New Jersey
ED WHITFIELD, Kentucky               SHERROD BROWN, Ohio
CHARLIE NORWOOD, Georgia             BART GORDON, Tennessee
BARBARA CUBIN, Wyoming               BOBBY L. RUSH, Illinois
JOHN SHIMKUS, Illinois               ANNA G. ESHOO, California
HEATHER WILSON, New Mexico           BART STUPAK, Michigan
JOHN B. SHADEGG, Arizona             ELIOT L. ENGEL, New York
CHARLES W. ``CHIP'' PICKERING,       ALBERT R. WYNN, Maryland
Mississippi, Vice Chairman           GENE GREEN, Texas
VITO FOSSELLA, New York              TED STRICKLAND, Ohio
ROY BLUNT, Missouri                  DIANA DeGETTE, Colorado
STEVE BUYER, Indiana                 LOIS CAPPS, California
GEORGE RADANOVICH, California        MIKE DOYLE, Pennsylvania
CHARLES F. BASS, New Hampshire       TOM ALLEN, Maine
JOSEPH R. PITTS, Pennsylvania        JIM DAVIS, Florida
MARY BONO, California                JAN SCHAKOWSKY, Illinois
GREG WALDEN, Oregon                  HILDA L. SOLIS, California
LEE TERRY, Nebraska                  CHARLES A. GONZALEZ, Texas
MIKE FERGUSON, New Jersey            JAY INSLEE, Washington
MIKE ROGERS, Michigan                TAMMY BALDWIN, Wisconsin
C.L. ``BUTCH'' OTTER, Idaho          MIKE ROSS, Arkansas
SUE MYRICK, North Carolina
JOHN SULLIVAN, Oklahoma
TIM MURPHY, Pennsylvania
MICHAEL C. BURGESS, Texas
MARSHA BLACKBURN, Tennessee

                      Bud Albright, Staff Director

        David Cavicke, Deputy Staff Director and General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

              Subcommittee on Oversight and Investigations

                    ED WHITFIELD, Kentucky, Chairman

CLIFF STEARNS, Florida               BART STUPAK, Michigan
CHARLES W. ``CHIP'' PICKERING,         Ranking Member
Mississippi                          DIANA DeGETTE, Colorado
CHARLES F. BASS, New Hampshire       JAN SCHAKOWSKY, Illinois
GREG WALDEN, Oregon                  JAY INSLEE, Washington
MIKE FERGUSON, New Jersey            TAMMY BALDWIN, Wisconsin
MICHAEL C. BURGESS, Texas            HENRY A. WAXMAN, California
MARSHA BLACKBURN, Tennessee          JOHN D. DINGELL, Michigan,
JOE BARTON, Texas,                     (Ex Officio)
  (Ex Officio)

                                  (ii)

  
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                         Letter of Transmittal

                     U.S. HOUSE OF REPRESENTATIVES

                    COMMITTEE ON ENERGY AND COMMERCE

              SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS

                                                   November 2, 2005
    To the Members of the Committee on Energy and Commerce:
    It is our pleasure to forward to you for your information 
the bipartisan report entitled ``Waste, Fraud, and Abuse 
Concerns in the E-rate Program,'' unanimously adopted by the 
Subcommittee on Oversight and Investigations on October 18, 
2005. This report details the Subcommittee's two-year 
investigation of the E-rate program, which is the Universal 
Service funding mechanism that subsidizes the provision of 
advanced telecommunications services for schools and libraries.
    The Subcommittee's investigation revealed a well-
intentioned program that nevertheless has suffered from poor 
implementation from the very start. These structural weaknesses 
made it particularly susceptible to waste, fraud, and abuse--
specific cases of which were examined during four Subcommittee 
hearings on the E-rate program. To be sure, Congress shares 
some responsibility for the program's flaws because the program 
is founded on a very general statutory basis. Looking forward, 
more time should be devoted to crafting the legislative 
framework of this program to ensure it achieves the goals that 
we want it to achieve.
    It is clear to us, as we consider the work laid out in this 
report, that many E-rate program weaknesses must be addressed 
legislatively to avoid waste and misuse. In light of this, we 
are transmitting this report to the full Energy and Commerce 
Committee, and commend it particularly to our colleagues on the 
Telecommunications and Internet Subcommittee, so that our work 
can assist the Committee in crafting the appropriate 
legislative proposals. The report provides a bipartisan list of 
findings, and a set of eleven principles that should help guide 
our deliberations over program reform. We appreciate your 
giving it your careful consideration.
            Sincerely,
                                 Ed Whitfield, Chairman    
                                Bart Stupak, Ranking Member
                       Subcommittee on Oversight and Investigations

                                 (iii)

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                            C O N T E N T S

                               __________
                                                                   Page

    I. Introduction and Overview.................................     1
    Key Findings.................................................     1
    Recommendations..............................................     3
    II. Background...............................................     5
    The E-rate Program...........................................     5
    The Subcommittee Investigation...............................     8
    III. Case Studies and other work of the Investigation........    10
    A. E-rate and the Puerto Rico Department of Education........    10
    Findings from PRDOE-focused hearing and related investigation    13
    B. San Francisco Unified School District's E-rate Experience, 
      and NEC BNS................................................    19
    Findings from NEC-focused hearings and related investigation.    22
    C. The Denial of $500 million in applicant requests 
      associated with IBM........................................    24
    Findings from IBM-focused hearing and related investigation..    26
    D. E-rate related investigation of Chicago Public Schools....    31
    Findings from Chicago Public Schools related investigation...    34
    E. E-rate related investigation of Atlanta Public Schools....    38
    F. GAO Work Requested by the Committee.......................    41
    GAO Recommendations..........................................    46

                                  (iv)

  
             WASTE, FRAUD, AND ABUSE CONCERNS WITH

                       THE E-RATE PROGRAM

                 Bipartisan Staff Report for the Use of

                  The Committee on Energy and Commerce

                            October 18, 2005

                      I. INTRODUCTION AND OVERVIEW

    In 1996, Congress mandated that schools and libraries 
receive discounted telecommunications services through the 
newly codified Universal Service Fund. In turn, the Federal 
Communications Commission (FCC) proceeded to implement that 
mandate, commonly known today as the E-rate program, through a 
private non-profit corporation known as the Universal Service 
Administrative Company (USAC). Within USAC, the Schools and 
Libraries Division (SLD) is responsible for the daily 
administration of the E-rate program. Between 1998 and the 
present time, USAC has ``committed'' over $15 billion and 
disbursed over $10 billion, to discount the costs of eligible 
telecommunications projects for schools and libraries 
throughout the country.
    While E-rate has arguably benefited the nation's children, 
the program falls far short as an example of efficiency, 
effectiveness, or integrity. In fact, the Subcommittee on 
Oversight and Investigations' in-depth examination of the E-
rate program uncovered serious instances of waste, fraud, and 
abuse. This work highlighted instances in which all program 
participants--the FCC, USAC, schools, and vendors--have 
neglected their respective obligations and responsibilities 
under the program's rules.
Key Findings
    The Subcommittee's investigation developed along several 
directions, culminating in three public ``case study'' style 
hearings and the compilation of significant additional 
information regarding the E-rate programs at Chicago Public 
Schools and Atlanta Public Schools. Further information was 
developed, at the direction of the Subcommittee, through a 
comprehensive review by the Government Accountability Office 
(GAO), which was reviewed in a fourth public hearing on the E-
rate program. Key findings from the Subcommittee investigation 
include:

 The FCC crafted an ambitious multi-billion-dollar funding 
        program, utilizing an ``unusual'' organizational 
        structure, and then never conducted a comprehensive 
        assessment to determine which federal requirements, 
        policies, and practices apply to the E-rate program, to 
        USAC, or to the Universal Service Fund itself.
 Although more than $15 billion has been ``committed'' by the 
        E-rate program during the past 8 years, the FCC did not 
        develop performance goals and measures that could be 
        utilized to assess the specific impact of the funds and 
        to improve the management of the program.
 The FCC's three key oversight mechanisms for the E-rate 
        program--rulemaking procedures, beneficiary audits, and 
        reviews of USAC decisions (i.e., appeals decisions)--
        are not sufficient to manage the program.
 Over the course of three program years, more than $100 
        million in E-rate funds were provided to one large 
        school district after it certified that its E-rate 
        funded network would be operational and put to 
        educational use, when, in fact, it was never made 
        operational or put to any significant educational use.
 The FCC's failure to help resolve the above school district's 
        enormous mismanagement and planning problems 
        contributed to the waste of E-rate funds, and reflects 
        the underlying deficiencies of the FCC's program 
        management and oversight.
 Currently, the E-rate program does not require beneficiaries 
        of large sums of E-rate funds to comply with standard 
        federal oversight and accounting requirements, such as 
        the Single Audit Act.
 Some school districts have acquired goods and services 
        through the E-rate program without using a formal 
        bidding process, contrary to both the program's rules 
        and local regulations, even though those districts 
        might have otherwise followed the E-rate Form 470 
        application process.
 A fundamental weakness in the program involves technology 
        planning. Some school districts have received E-rate 
        related goods and services without an adequate 
        technology plan. More broadly, E-rate's current 
        technology plan requirements provide no meaningful 
        protection from ``gold-plating'' (procurement of 
        technology goods and services far beyond reasonable 
        school district needs and resources).
 The FCC Inspector General (IG) cannot provide adequate 
        assurance that the program is sufficiently protected 
        against waste, fraud, and abuse. Furthermore, the FCC 
        Wireline Competition Bureau (WCB) does not know the 
        magnitude of potential fraud.
 The FCC IG faces several obstacles in implementing effective 
        independent oversight of the program, including 
        insufficient resources to conduct audits and provide 
        audit support to law enforcement investigations.
 The certifications contained on E-rate program application 
        documents apparently have little effect in deterring 
        some school officials and some vendors from taking 
        advantage of the program's weaknesses. In one case 
        examined by the Subcommittee, school officials and 
        several employees of service providers forged documents 
        and signatures as part of a conspiracy to defraud the 
        E-rate program.
 Weak E-rate program competition requirements and inadequate 
        oversight allowed a group of vendors to completely 
        manipulate the competitive process for E-rate program 
        goods and services, without USAC detecting the fraud.
 Weaknesses in the E-rate program application process and 
        related certifications permitted non-competitive 
        procurement of E-rate program goods and services around 
        the country in Funding Years 2001 and 2002. The flawed 
        application process resulted in the waste of millions 
        of dollars in one school district in Funding Year 2001, 
        and almost led to the waste of tens of millions more 
        among 21 other large school districts in Funding Year 
        2002. Today, the FCC continues to allow anti-
        competitive or insufficiently competitive procurement 
        practices, due to remaining weaknesses in the 
        application process.
 The FCC only recently established guidelines for debarment of 
        vendors and applicants, but set standards of program 
        abuse too high, requiring first a civil judgment or 
        criminal conviction against the participant before a 
        suspension may occur and debarment can be considered.
 The E-rate program's ambiguous rules and procedures, and 
        extensive delay in the distribution of funding, create 
        significant confusion among applicants and vendors. 
        This confusion and delay tends to increase program 
        waste.
 E-rate program fund disbursements generally go directly to 
        vendors, rather than being disbursed through the 
        program applicants (the schools and libraries), which 
        lessens applicants' control over work performed and 
        diffuses responsibility and accountability for program 
        integrity; although this structure stems from the FCC's 
        interpretation of the underlying statutory language, it 
        nevertheless makes oversight and enforcement more 
        difficult.
    In sum, the Subcommittee's investigative work reveals a 
well-intentioned program that nonetheless is extremely 
vulnerable to waste, fraud, and abuse, is poorly managed by the 
FCC, and completely lacks tangible measures of either 
effectiveness or impact. This bipartisan staff report 
recommends certain principles that should guide any effort to 
improve the E-rate program. These principles are substantially 
based upon the results of the Subcommittee's investigation and 
staff opinion that effective improvements may likely require 
significant legislative reform.
Recommendations:
    Based upon the results of the E-rate program investigation, 
staff identified several overarching principles that should 
guide program reform:

1) The FCC and USAC must conduct more rigorous oversight. To 
        accomplish the necessary rigorous oversight and strong 
        program auditing, the FCC and USAC require adequate 
        personnel resources.
2) The E-rate program must have concrete and achievable goals 
        and measures of effectiveness, so that Congress can 
        assess the specific impact and value of program 
        spending. Among a number of key issues, Congress should 
        consider: (a) whether the FCC is the proper agency to 
        manage and oversee the E-rate program; (b) whether the 
        largely arbitrary $2.25 billion annual price tag is 
        appropriately set; (c) whether control and management 
        of this large sum is appropriately delegated to a non-
        governmental entity; and, (d) the extent to which E-
        rate program discounts should cover technological 
        infrastructure and related services, i.e., whether the 
        program covers too much, or should expand to subsidize 
        key technology components that are not currently 
        eligible, such as computers, software, and teacher 
        training.
3) In the interest of ensuring the maximum return on E-rate 
        program funds, the E-rate program must have a mechanism 
        to ensure that ``gold-plating'' is minimized. That is, 
        schools should request and receive only what they 
        genuinely will put to effective use, and technology 
        plans should not be an empty exercise. The FCC and USAC 
        should develop a mechanism to verify that applicants' 
        requests match legitimate education-technology needs; 
        this will require revising the technology planning 
        process and requirements.
      Among other things, complete and approved E-rate program 
        technology planning documents should be the required 
        first step before posting a Form 470. These planning 
        documents cannot be broad-brush, but rather need to: 
        (a) account for the current state of the supporting 
        physical infrastructure at each school for which 
        funding is requested; (b) specify exactly how the 
        technology will be implemented in support of the 
        curriculum, including details of the necessary level of 
        teacher training and the school district's plan for 
        providing such training; and (c) include the district's 
        specific budget commitments for infrastructure, 
        training, and maintenance, as well as the computers and 
        other complementary equipment required to make use of 
        the E-rate program funded internal connections being 
        requested.
4) Reform should incorporate the GAO's recent recommendations 
        for the FCC, including that the FCC: (a) 
        comprehensively determine which federal accountability 
        requirements apply to E-rate; (b) establish meaningful 
        E-rate program performance goals and measures; and (c) 
        take steps to reduce its backlog of appeals. The FCC 
        must take these necessary and reasonable actions in 
        order to begin to address the problems identified by 
        this Subcommittee, the FCC IG, and the GAO. In 
        addition, Congress should consider directing the GAO to 
        continue its examination of the E-rate program, 
        focusing on the issues relating to the complexities 
        posed by the FCC's organizational relationship with 
        USAC and provide guidance to Congress and the FCC on 
        the questions that flow from this organizational 
        structure.
5) The E-rate program requires an organizational structure that 
        encourages greater accountability of all program 
        participants--including vendors, consultants, schools, 
        USAC, and the FCC Wireline Competition Bureau.
6) The FCC must acquire, and promptly provide to Congress, some 
        tangible measure of the extent and scope of program 
        waste, fraud, and abuse, i.e., statistically 
        significant auditing must be undertaken immediately and 
        accomplished before the end of this Congress. The 
        necessary resources should be made available to ensure 
        an appropriate number of beneficiary audits can be 
        performed to make an accurate assessment of program 
        waste, fraud, and abuse.
7) School districts should hold a greater ``stake'' in their 
        applications for E-rate program discounts. This may be 
        accomplished in a number of ways, including several 
        possibilities that were suggested during the 
        Subcommittee's hearings, such as: (a) requiring higher 
        co-payments by the school districts; (b) drafting 
        certifications for vendors and school officials that 
        include tougher criminal penalties; (c) restructuring 
        the program into a reimbursement paradigm (i.e., direct 
        reimbursement to schools and libraries); or (d) 
        conducting verification and inspection of E-rate 
        program related work before discounts are paid out. 
        There are likely other creative options to achieve this 
        goal, as well.
8) The E-rate program requires stronger ``built-in'' 
        disincentives to waste, fraud, and abuse (as opposed to 
        the external disincentives of FCC IG auditing or 
        Justice Department criminal prosecution), including 
        such options as mandatory audits, civil penalties for 
        rule violations, and more flexible provisions for 
        program debarment.
9) The program needs a much more robust competitive bidding 
        structure than it currently possesses, in order to 
        ensure that E-rate program funds support the highest 
        per-dollar value possible. Achieving this goal is not 
        simply a matter of mandating that price should be 
        considered the primary factor. Congress should consider 
        whether an adequate competitive bidding environment 
        could be better assured by incorporating relevant 
        portions of the Federal Acquisition Regulations (FAR) 
        to the E-rate program's rules and regulations.
10) The FCC and USAC should act immediately to specify that, 
        for all ``Priority II'' (internal connections) 
        applications exceeding a reasonable threshold, a 
        portion of the district's approved funding must be set 
        aside for an independent audit of the total funds 
        committed. Further, USAC must be provided with a copy 
        of all audit results within 30 days of audit completion 
        and within one year of the expenditure.
11) The GAO should examine the potential for (and scope of any) 
        waste, fraud, and abuse in the E-rate program's funding 
        of ``Priority I'' services (telecommunications and 
        Internet access fees).

                             II. BACKGROUND

    The E-rate Program. Under the Telecommunications Act of 
1996 (P.L. 104-104) (the Act), Congress codified a longstanding 
policy commitment to ensure ``universal service'' in the 
provision of telecommunications services, and expanded that 
policy to cover schools and libraries. Specifically, to 
``assure that no one is barred from benefiting from the power 
of the information age,'' 1 Congress mandated that 
elementary and secondary schools, and libraries, be offered 
discounted access to telecommunications services for 
educational purposes, including ``advanced'' telecommunications 
services.
---------------------------------------------------------------------------
    \1\ See Telecommunications Act of 1996, Conference Report, U.S. 
House of Representatives (Report 104-458) at 132-33.
---------------------------------------------------------------------------
    Consequently, the FCC, which is responsible for 
implementing universal service policy, established the Schools 
and Libraries Universal Support Mechanism--more popularly known 
as the E-rate program. In late 1997, the program began 
preparations for providing discounts to eligible schools and 
libraries for fiscal year 2 1998. The E-rate program 
is funded through the Universal Service Fund (USF, or, the 
Fund), which is supported by a ``Universal Service Fee'' 
charged to telecommunications providers--and which is usually 
passed on to consumers' phone bills.3 USAC 
administers the Fund under the direction of the FCC. USAC is a 
non-profit corporation and wholly-owned subsidiary of the 
National Exchange Carrier Association (NECA), whose members are 
comprised of about 900 ``local'' telephone 
companies.4 In 2004, USAC disbursed approximately 
$5.7 billion in support of four ``universal support 
mechanisms'': $3.5 billion for the ``high cost'' program, $760 
million for the ``low-income'' program, $21.7 million for the 
``rural health care'' program, and $1.4 billion for the E-rate 
program.
---------------------------------------------------------------------------
    \2\ An E-rate program fiscal year is referred to herein as a 
``Funding Year.'' Generally, a given E-rate Funding Year runs from July 
1st of one calendar year to June 30th or September 30th of the next 
calendar year, depending on the category of goods or services funded.
    \3\ At the time of this report, the fee assessed on rate-payers' 
phone bill amounts to 10% of the total long distance calling costs.
    \4\ The genesis of the organizational structure and relationship of 
USAC, NECA, and the FCC, and the resulting concerns, are explained in 
more detail infra, pages 46-47, and also in the GAO Report prepared for 
the Committee.
---------------------------------------------------------------------------
    The E-rate program provides funding to service providers 
(telecommunications vendors) to support discounts for schools 
and libraries in three service categories: telecommunications, 
Internet access, and ``internal connections'' (i.e., the 
cabling and network infrastructure necessary for multiple users 
within schools to access the Internet). The discounts range 
from 20% to 90% of the costs of eligible products and services, 
depending on both the rate of participation in the National 
School Lunch Program and the urban/rural status of the school 
or school district. USAC publishes a comprehensive and annually 
updated list of goods and services that are eligible for E-rate 
program discounts.
    As of October 2005, USAC collected and approved for 
disbursement roughly $15 billion since the program's start. 
Approximately $10 billion of that amount has actually been 
disbursed to E-rate program service providers. The amount of 
funding available each year for the E-rate program is capped at 
$2.25 billion. However, current rules permit unused fund 
balances to be rolled over to following years. Thus, $2.4 
billion was available for funding commitments in 2004. Each 
year, requests from nearly 40,000 applicants for E-rate program 
funds far exceed the available funding. (Approximately $4.3 
billion in requests were submitted in 2004.) Because of the 
limited funds, program rules prioritize discount commitments 
first by type of service and then by discount level of the 
applicant. Under program rules, all eligible applicants receive 
support for so-called ``Priority I'' services--that is, 
telecommunications and Internet access fees. Only applicants 
qualifying for very high discounts (typically at 80% and 
higher) receive the remaining support for internal connections, 
or ``Priority II'' services, which account for the largest 
amount of applicant funding requests.
    USAC develops and implements procedures, under the 
supervision of the FCC, to administer the E-rate program in 
accordance with the program rules.5 Essentially, for 
an eligible applicant to receive funding it must choose 
services that it intends to use effectively for educational 
purposes, and must do so through a competitive bidding process 
(to ensure cost effectiveness). Applicants must also certify 
that they have the resources--including a budget, computers, 
teacher training, and infrastructure--necessary to make 
effective use of the products and services for which they 
request discounts. Put another way, applicants are required to 
``do their homework'' before applying for funds. Schools 
accomplish this by developing technology plans, which are meant 
to set forth in detail how the applicant intends to use the 
technologies and how it plans to integrate technology into its 
curriculum.-- Applicants also must bear the costs for any 
necessary initial planning for the implementation of E-rate 
program products and services, such as design of technology 
architecture, determination of project scope, and evaluation of 
the products and services needed.
---------------------------------------------------------------------------
    \5\ See Code of Federal Regulations (CFR), Title 47, Part 54, 1 
et. seq.
---------------------------------------------------------------------------
    After determining the products and services for which they 
will seek E-rate program discounts, the applicants file--for 
posting on USAC's Web site--an FCC ``Form 470.'' Applicants 
must supply information on this basic form with sufficient 
specificity for potential bidders to formulate bids for 
eligible E-rate program products and services. According to the 
statute, E-rate program discounts must be provided to eligible 
applicants who make a ``bona fide request'' for products and 
services for educational purposes. Through its May 8, 1997 
Universal Service Order, the FCC attempted to implement this 
requirement by mandating that applicants (i.e., the school or 
school district): 6 ``(1) conduct internal 
assessments of the components necessary to use effectively the 
discounted services they order, (2) submit a complete 
description of the services they seek so that it may be posted 
for competing service providers to evaluate, and (3) certify to 
[sic] certain criteria under penalty of perjury.'' 7
---------------------------------------------------------------------------
    \6\ This report's references to schools and school systems apply to 
libraries as well.
    \7\ See Federal-State Board on Universal Service, CC Docket No. 96-
45, Report and Order, FCC 97-157,  570.
---------------------------------------------------------------------------
    Since the program's inception, the integrity of this E-rate 
program application process has relied (almost exclusively) 
upon applicants to (1) certify that they possess the necessary 
resources and plans to use the products and services for which 
they request E-rate program subsidies, and (2) choose the most 
cost-effective products and services through a competitive 
bidding process for those products and services. When 
applicants subsequently select the most cost-effective bid or 
bids, price must be the primary factor considered. After 
winning vendors are chosen from the pool of bidders, the--
applicant requests funding from USAC for specific products and 
services on an FCC ``Form 471.''
    After the applicant files a Form 471, having its own set of 
mandatory certifications, USAC evaluates the request and then 
makes a funding commitment to the applicant, adjusting the 
request if necessary or rejecting the request outright if it 
fails to conform to the program's rules. E-rate program funds 
are disbursed by USAC's Schools and Libraries Division (SLD) 
directly to service providers, based upon invoices submitted by 
the service provider and a certification submitted by the 
applicant that installation of the products and services has or 
is about to commence, or has been completed. Applicants submit 
their ``co-payment'' for the E-rate program goods and services 
directly to the service providers.
    While disbursing funds, USAC also conducts invoice review, 
special investigations, and site visits when circumstances 
warrant. Finally, USAC draws on both its internal audit staff 
and independent auditors (in consultation with the FCC and the 
FCC IG) to gather further information regarding program 
integrity and to identify waste, fraud, or abuse of the 
disbursed funds.
    Since the program's inception, however, serious questions 
concerning the ability of these administrative processes to 
effectively tackle the risks of waste, fraud, and abuse have 
been repeatedly raised--despite some continuing efforts to 
improve program oversight and management by both the FCC and 
USAC. These questions highlight fundamental weaknesses in the 
program's application and review processes, as well as in the 
overall structure and direction of the program.
    The Subcommittee Investigation. In January 2003, the 
Subcommittee on Oversight and Investigations initiated its 
investigation of the E-rate program to examine the potential 
for waste, fraud, and abuse in the program. The investigation 
was in part prompted by news reports of incidents in December 
2002 that suggested serious problems of program waste, fraud, 
and abuse. In particular, a New York City E-rate program vendor 
was indicted on federal charges for defrauding the E-rate 
program. Additionally, the FCC IG's October 31, 2002, semi-
annual report to Congress described a number of concerns with 
the program, as well as the rise in law enforcement activity, 
including the creation of a special Department of Justice (DOJ) 
E-rate program task force. Further, the FCC IG criticized the 
insufficient funding devoted to oversight and concluded that, 
``until such time as resources and funding are available to 
provide adequate oversight for the USF program, we are unable 
to give the Chairman, Congress and the public an appropriate 
level of assurance that the program is protected from fraud, 
waste and abuse.''
    At the outset, Committee staff interviewed FCC and USAC 
officials, GAO staff, as well as some E-rate program vendors, 
to identify the scope and nature of the issues affecting the E-
rate program. That initial work revealed that problems of 
waste, fraud, and abuse have followed the E-rate program from 
the beginning. For example, Committee staff learned that the 
relatively small number of targeted audits of funding 
beneficiaries over the first two years identified more than $10 
million in inappropriate funding disbursements.
    Also at this time, there were approximately 30 active 
Federal and state investigations of either vendors or 
recipients of E-rate program funds around the United States--
involving, in aggregate, more than $200 million of questionable 
funding. Moreover, ongoing and ensuing work by the FCC IG, and 
concerns raised by both the IG and the GAO, revealed an 
inadequate system of E-rate program oversight. The IG had 
estimated that the E-rate program, given the magnitude of its 
yearly funding, may face up to $180 million in improper and 
fraudulent disbursements annually, based upon a GAO analysis of 
similar-sized programs. This also suggested that the emerging 
evidence of fraud and abuse around the country might just be 
the tip of an iceberg. Committee concerns on this front were 
underscored by the absence of a statistically representative 
audit of the full program. As a result, the Committee had 
little reassurance that the efforts made by the FCC and USAC to 
administer the E-rate program and to improve program oversight 
and auditing were actually addressing the full extent of the 
problems.
    In light of this information, then-Chairman Tauzin and 
then-Subcommittee Chairman Greenwood wrote the FCC and USAC on 
March 13, 2003, requesting records relating to implementation, 
oversight, and management of the E-rate program.8 
Further review of preliminary information from vendors and 
applicants participating in the program prompted the Committee 
to seek information on the implementation of E-rate program 
products and services at the school level. Data showed that the 
largest potential for waste, fraud, and abuse resided with the 
provision of ``internal connections'' (Priority II) products 
and services. Accordingly, staff identified several internal 
connections service providers whose participation in the 
program was particularly large and active.9 On July 
14, 2003, then-Chairman Tauzin and then-Subcommittee Chairman 
Greenwood wrote to the five largest internal connections 
vendors over the duration of the E-rate program (by funding 
receipts), including the companies SBC Telecommunications and 
IBM. Additionally, the Committee wrote to seven other vendors 
that ranked among those with the largest rate of increase in 
internal connections funding requests (over $30 million for any 
given year), which included the company NEC Business Network 
Solutions, among others.
---------------------------------------------------------------------------
    \8\ The requests to USAC, which fully cooperated in the document 
production, were augmented by a subpoena on April 29, 2003 for certain 
records that USAC could not initially provide due to confidentiality 
concerns.
    \9\ The investigation focused on waste, fraud, and abuse in 
provision of Priority II funding; it did not examine the provision of 
Priority I services to determine the extent, if any, of problems under 
that category of funding. The FCC IG testified that his office has not 
conducted enough work to draw a conclusion about problems in that 
funding category, and acknowledged that waste, fraud, and abuse may 
exist there as well.
---------------------------------------------------------------------------
    Subsequent document productions and related interviews 
focused the inquiry on certain topics that illuminated some of 
the main problems plaguing the E-rate program. The staff 
pursued several case studies that resulted in four public 
hearings by the Oversight and Investigations Subcommittee, as 
well as additional work that, while not directly addressed 
during the hearings, provided further information that has 
proven helpful in identifying major program issues.
    In the course of this work, it is important to note, the 
Committee staff observed instances of the E-rate program 
working effectively. Such cases helped to underscore the 
importance of identifying E-rate program weaknesses and 
vulnerabilities, and of developing meaningful fixes to the 
program.
    An example of the E-rate program's potential can be found 
on the southwest side of the City of Chicago, at the Nathaniel 
Greene Elementary School (Greene School). Of the 803 students 
in kindergarten through fifth grade at Greene, 88% are 
Hispanic. For many, if not most, English is a second language. 
Roughly 94% of the students are enrolled in the free or reduced 
lunch program. Nonetheless, the combination of technology, 
determined administrators, and a well-trained and dedicated 
faculty is transforming the educational experience to a level 
comparable with the best that suburban schools have to offer. 
Not only are computers used effectively in the lab and the 
library, but in each classroom as well. Even a brief visit 
found kindergarten students spelling out words on their 
computers, third grade students preparing PowerPoint 
' presentations, fifth grade students forecasting 
the weather, and a science fair that would impress any 
elementary school teacher. Most important, the children were 
truly engaged in the learning process and appeared to delight 
in their assignments. The E-rate program has played a big role 
in providing the opportunity for learning in this inner-city 
community.10
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    \10\ The Greene School's Web site can be found at http://
www.greene.cps.k12.il.us/
---------------------------------------------------------------------------
    The School District of Philadelphia presents another 
positive example of the E-rate program's impact. When that 
district began to participate in the E-rate program, much of 
the school district's physical infrastructure was obsolete and 
it had already completed a five-year plan to modernize 
education-related technology. Instead of falling for vendor 
temptation to ``gold-plate'' problem schools, Philadelphia 
chose a slower and economically reasonable path to maximize the 
efficient use of technology. The school district applied for E-
rate program funds only as the technology plan dictated, and it 
never requested more than could be effectively integrated in 
any given year.
    School district officials used the E-rate program as a 
complement, not as a crutch. Local funding sources were used to 
upgrade the schools' electrical systems, buy computers, develop 
software, and, in part, to install wireless networks and 
construct a fiber-optic network. Philadelphia's plan emphasized 
and funded training for teachers and students. School district 
officials tied the installation of technology in each of the 
schools to both professional development and specific 
curriculum needs--hence, assuring productive and efficient use. 
The school district refrained from installing expensive 
technology simply because E-rate program funds were available.
    Philadelphia's completion of an integrated and 
comprehensive technology plan, effective teacher training, and 
resistance to overstating its needs or procuring unnecessary 
goods and services, all demonstrate the proper use of the E-
rate program.

         III. CASE STUDIES AND OTHER WORK OF THE INVESTIGATION

    The following section details the key facts of specific 
case studies and their related hearings, followed by additional 
information relating to those parts of the investigation 
concerning E-rate program participation by Chicago Public 
Schools and Atlanta Public Schools, and finally, a discussion 
regarding the GAO's recent E-rate program report that was 
requested by the Subcommittee.
A. E-rate and the Puerto Rico Department of Education (PRDOE)
    In the case of Puerto Rico's experience with seeking E-rate 
program discounts for its public schools, the situation 
involved: (1) questionable planning and a clear failure by 
administrators of the school district to make any use of E-rate 
program funded infrastructure and ensure the integrity of the 
investment of E-rate program funds; (2) questionable 
implementation of and billing for E-rate program products and 
services by the vendors, Puerto Rico Telephone Company (PRTC) 
and Data Research Corporation (DRC); and, (3) a critical 
failure on the part of USAC and especially the FCC to respond 
effectively to the severity of a situation in which more than 
$100 million of E-rate program funds had been spent, with 
nothing significant to show for it. Thus, 50,000 students have 
been graduating each year from the largest school system in the 
country without having any of the broadband Internet access 
(IA) that the program is intended to support.
    PRDOE operates the entire public school system for the 
Commonwealth of Puerto Rico, overseeing approximately 610,000 
students and 1,540 schools. By number of school facilities, the 
system is the largest in the United States (by comparison, the 
New York City Board of Education administers 1,200 schools but 
one million students, and ranks second). Additionally, Puerto 
Rico is among the poorest school districts in the United 
States, eligible for 90% E-rate program discounts district-
wide.
    PRDOE applied for funding in each of the first six years of 
the E-rate program--from 1998 to 2003--and has not applied for 
funding since. In the first three years of the program--1998, 
1999, and 2000--USAC committed and disbursed funds on behalf of 
PRDOE to two service providers, PRTC and DRC. All told, USAC 
disbursed $101.2 million during this period--with PRTC 
receiving a total of $31.6 million for the supply of Internet 
access and broadband (T1) service, and DRC receiving a total of 
$69.6 million for a combination of internal connections 
(totaling $58.6 million), Internet access, and T1 service fees. 
PRDOE's E-rate program applications stated that the funding was 
intended to support broadband service and the underlying 
infrastructure to enable Internet access for all 1,540 schools.
    A new governor of Puerto Rico, elected in November 2000, 
appointed a new Secretary of Education, who assumed leadership 
of PRDOE in January 2001. After assuming office, the new 
administration continued the Funding Year's E-rate program 
application process started by the departing administration. 
Over the course of 2001, the new PRDOE administration 
progressively learned through vendors, school personnel, and 
site visits of chronic problems within the schools--in terms of 
electrical infrastructure, security, inadequate teacher 
training, and other facility problems. Most important, the fact 
emerged that very few schools--and virtually no students--
actually had access to computers connected to the Internet.
    In the spring of 2001 the Office of the Comptroller of 
Puerto Rico reported its preliminary findings of an audit of 
PRDOE's E-rate program to the FCC IG, noting concerns about 
competitive bidding irregularities. The IG collected 
information on PRDOE from USAC and proceeded to make a referral 
to the U.S. Department of Justice (DOJ). (At the same time, the 
DOJ was investigating broader corruption by the former 
Secretary of Education, who later was indicted and convicted, 
and is serving 12 years in federal prison.) In October 2001, an 
Arthur Andersen audit conducted during the summer of 2000 was 
released. The audit showed that PRDOE had failed to acquire 
some 100,000 computers to be used by students to connect to the 
E-rate program funded infrastructure. On December 5, 2001, USAC 
wrote PRDOE requesting a report on questions generated by the 
audit, stating that PRDOE's outstanding E-rate program 
applications would not be processed or any more funds disbursed 
until USAC received and evaluated the information. To date, 
$102 million in requests (for Funding Years 2001, 2002, and 
2003) still await USAC decisions.
    PRDOE responded to USAC's inquiries on January 15, 2002, 
with additional information about problems it had identified in 
the management and planning of E-rate program related work done 
by the previous administration, and also identified steps it 
was taking to rectify the situation. Over the course of the 
next year, PRDOE made presentations to USAC and FCC staff, 
describing efforts to ensure resources were available and to 
rectify problems identified in the workings of the network. By 
January 30, 2003, PRDOE had petitioned the FCC to direct USAC 
to process its applications.
    In May 2003, the FCC issued a request for public comment on 
PRDOE's petition for the continued processing of the 
outstanding E-rate program funding requests. On November 14, 
2003--two years after E-rate program funding was halted--the 
FCC issued an order directing USAC to (1) process applications 
for 2001 and 2002, except for DRC-related funding, but only 
subsequent to an audit; and (2) investigate the use of E-rate 
program funds during Funding Years 1998, 1999, and 2000, after 
which the FCC would evaluate the results and determine 
appropriate action. DRC-related funding was held due to 
allegations of on-going investigations of DRC by authorities in 
Puerto Rico and the United States.
    In February 2003, following interviews with relevant 
parties at PRDOE, PRTC, DRC, USAC, and the FCC, Committee staff 
visited Puerto Rico to examine the infrastructure and high-
speed network that the E-rate program had funded, and to 
determine the extent of the efforts by the current PRDOE 
administration to put the system to effective use. During the 
visit, Committee staff discovered nearly $23.5 million in E-
rate program funded equipment in a PRDOE warehouse, in 
violation of program rules. The gear included about 73,000 
``wireless cards'' that were to be used in PRDOE computers for 
the wireless portion of PRDOE's network. The Committee staff 
found the equipment shrink-wrapped and sitting on storage 
pallets. Committee staff also observed that, in the schools 
that they visited, there were very few, if any, computers 
dedicated to utilizing the E-rate program funded network, and 
especially the wireless half of the network. Staff also 
observed substandard equipment installation, placement of 
servers and switches near open windows, and little security for 
protecting equipment from vandalism. Due in part to a grossly 
inadequate number of computers available for utilization of the 
system, a roughly $58 million high-speed computer network 
remained virtually unused.
    Further, USAC paid $43 million for T1 service and Internet 
access fees, but because of the very small number of computers 
and the inadequate training of teachers very few school 
children ever benefited educationally from the learning 
resources broadband Internet access made available by paying 
these fees. At the time of the staff visit, Puerto Rico's 
school children who could access the Internet did so via 56K 
dial-up modems--staff learned that broadband service had been 
terminated after July 2003 because, according to school 
district officials, USAC had not yet released more funding or 
processed outstanding E-rate program applications for such 
services.
    On June 17, 2004, the Subcommittee on Oversight and 
Investigations held the first of three hearings entitled: 
``Problems with the E-rate Program: Waste, Fraud, and Abuse 
Concerns in the Wiring of Our Nation's Schools to the 
Internet.'' The hearing examined: (1) the factors surrounding 
the evident failure of PRDOE to make effective use of more than 
$100 million of E-rate program funding from 1998 through 2001; 
(2) the role played by the school district's two principal E-
rate program service providers, PRTC and DRC; and (3) the 
actions taken by USAC and the FCC to identify and resolve the 
school district's problems, and what such actions demonstrated 
regarding oversight of the E-rate program generally.
    The hearing provided a case study of the E-rate program and 
the substantial waste of more than $100 million in one large 
school district, and highlighted programmatic weaknesses--in 
the application process, the certification process, technology 
planning, auditing, implementation of goods and services, 
resolution of problems by USAC and the FCC, and overall program 
guidance by the FCC.
Findings from the PRDOE-focused hearing and related investigation:
     Over the course of three years, more than $100 million in 
funds were provided after PRDOE certified that its E-rate 
program funded network would be operational and put to 
educational use, when, in fact, it was never made operational 
or put to any significant educational use.
    In the most egregious sign of this waste, funds were paid 
to vendors when the school district certified that key wireless 
components of the network infrastructure were installed and 
operational, when installation of those components had actually 
never occurred.
    The Committee staff discovery of $23.5 million of unused 
and unopened wireless cards in a PRDOE warehouse, which had 
been invoiced as delivered and installed, represents one of the 
most flagrant examples of the failure to deliver or make use of 
goods and services purchased through the E-rate program. (The 
investigation identified similar patterns of failure in other 
school districts as well, some of which are discussed below.) 
This failure signals an underlying weakness of the E-rate 
program; that is, the difficulty to ensure that E-rate program 
funded goods and services are put to effective educational use. 
It also underscores a weakness in USAC's reliance on 
certifications in lieu of independent verification. Until staff 
made the discovery, neither the FCC nor USAC knew of the 
warehoused equipment, although school district officials were 
fully aware of the circumstances. Moreover, these officials 
seemed unaware that the situation amounted to a major program 
rule violation.
    Puerto Rico's Comptroller testified that insufficient 
planning and oversight by PRDOE contributed to the 
nonfunctional network. Limited inspections by both the 
Comptroller and an outside consultant for the school district 
revealed inadequate facilities and security for equipment. 
Documents also revealed extensive problems, either due to 
equipment malfunctions or the lack of technical training, for 
the school district to maintain consistent connectivity to the 
Internet. The District neglected to provide training resources 
for teachers during the time of funding, further limiting the 
ability to make effective educational use of the E-rate program 
funds.
    Puerto Rico's deficiencies in resources, training, 
infrastructure maintenance, and equipment installation also 
underscore the weakness in applicant certifications. Puerto 
Rico had certified, as required by the E-rate program on every 
application, that it possessed the resources necessary to make 
effective use of the goods and services it was seeking. Yet 
this was clearly not the case, and the program's money was 
wasted. Given the annual number of E-rate program applications, 
independent verification of all requests may be prohibitively 
expensive; however, the situation in Puerto Rico underscores 
the critical need to ensure the penalties behind false 
certifications are sufficiently strong to effectively deter 
wasteful or fraudulent requests.
     Over two years, and for more than 700 schools, a monthly 
fee of up to $1,500 per school was charged for T1 lines that 
were essentially not being utilized.
    The failure to provide adequate internal connections 
infrastructure, sufficient computers for student access, and 
teacher training did not stop the E-rate program from paying 
for broadband service and Internet access. Hearing testimony 
and documents indicate that approximately $43 million was 
disbursed for either T1 lines or Internet access fees before 
the district's follow-on applications were placed on hold in 
December 2001. PRTC continued to provide broadband service for 
the portion of the district's schools under its contract (760 
schools at a monthly rate of $1,500 per school), irrespective 
of whether any schools were actively using the lines or had 
fully functioning internal networks. In the vast majority of 
cases, according to documents, testimony, and staff interviews, 
the networks were not utilized, but PRTC maintained that it was 
contractually obligated to provide the service. In the 
meantime, PRDOE neglected to alert USAC that E-rate program 
funds were supporting unused services. The E-rate program 
cannot mandate how often or how much a beneficiary actually 
uses the delivered goods and services; but the circumstances in 
Puerto Rico nonetheless reveal a weakness with regard to 
ensuring that the delivered goods and services are in fact used 
by students.
     The FCC did not help resolve PRDOE's enormous funding 
management and planning problems, and therefore contributed to 
both the waste of E-rate program funds and the failure of the 
program there. This shows one symptom of the underlying problem 
of the FCC's poor program management and oversight.
    The FCC and USAC squandered valuable time by delaying any 
intervention in Puerto Rico, thus effectively prolonging the 
school district's E-rate program problems. Throughout 2002, 
according to documents in the record, PRDOE continued 
infrastructure upgrades and informed the FCC and USAC regarding 
its progress, to ensure that resources would be available to 
put the E-rate funded internal connections to effective use. 
PRDOE reported spending approximately $136 million in facility 
upgrades, computer and infrastructure purchases, and training. 
In the course of meetings with USAC, the district stressed the 
urgent need for releasing the E-rate program funds in order to 
continue development of the network. During its October 1, 2002 
presentation, Puerto Rico requested that USAC act upon its 
Funding Year 2001 and 2002 requests--again citing its work to 
ensure resources would be available, and the urgency of making 
the E-rate program funded internal connections available to the 
school system.
    At the same time, according to the record and staff 
interviews, USAC and the FCC's Office of General Counsel, in 
coordination with staff at the FCC's Wireline Competition 
Bureau (WCB), prepared a plan to allow USAC to resume 
processing Puerto Rico's 2001 and 2002 applications, provided 
that the district made certain certifications. The FCC examined 
the U.S. Department of Education's prior work in Puerto Rico 
when developing the plan. The FCC's General Counsel outlined to 
the DOJ its intentions to process Puerto Rico's funding 
requests, and asked the DOJ to respond with objections within 
fourteen days. The FCC letter explained that absent any 
objections, it would ``go forward with the process of reviewing 
and granting, subject to conditions, PRDOE's application for 
funding years 3 and 4 [sic, years 4 and 5 were at issue].'' The 
FCC's self-described ``work-out'' conditions required PRDOE to 
enter a binding agreement to take various steps to establish 
compliance and demonstrate the ability to use the funds, 
including hiring an independent auditor at PRDOE's expense. The 
DOJ did not respond to the FCC. Subsequently, however, the FCC 
requested on January 30, 2003, that Puerto Rico submit a 
petition for the release of the funds. Initially, the FCC 
planned to process the district's petition as a unique case, 
without public notice. Puerto Rico's attorney told Committee 
staff that the FCC made no indication that the petition would 
be posted for public comment.
    In May 2003, however, the FCC decided that Puerto Rico's 
request should obtain public comment. According to Committee 
staff interviews with the FCC, the WCB decided that the 
district's funding request provided an opportunity for the 
agency to develop a broader policy concerning waste, fraud, and 
abuse in the E-rate program. Thus, the FCC abandoned its 
``work-out plan,'' and instead noticed the Puerto Rico petition 
on May 16, 2003 for public comment. On November 25, 2003--two 
years after USAC initially postponed further funding for Puerto 
Rico--the FCC issued an order instructing USAC to: (1) process 
funds for 2001 and 2002 (excluding any funding related to the 
vendor DRC), but only after USAC conducted an audit; and (2) 
investigate Puerto Rico's use of E-rate funds during Funding 
Years 1998, 1999, and 2000, following which the FCC would 
evaluate the results and determine any appropriate action.
    Notably, the FCC order did not contain the procedures 
detailed in the fall 2002 ``work-out plan.'' Much of the 
lengthy consultation and negotiation between the FCC and the 
district was abandoned in favor of a more arms-length approach. 
By contrast, with regard to Puerto Rico's use of fiscally 
unrelated federal education funds, the U.S. Department of 
Education (USDOE) has worked actively and closely with the 
district to resolve major financial control issues that arose 
under the Single Audit Act. The FCC's decision regarding Puerto 
Rico will likely delay resolution until well into 2005.
     The E-rate program does not presently require compliance 
with standard federal oversight requirements, such as the 
Single Audit Act.
    Important information regarding a given school district's 
management and use of federal funds is not collected as a 
matter of practice. From the program's inception, there has 
been much confusion surrounding the legal status of E-rate 
program funds, and the consequent statutory financial oversight 
and accounting activities that should result from that legal 
status. One example of this is the Single Audit Act of 1984, 31 
U.S.C. 7501 et. seq., which sets forth certain auditing 
requirements for ``non-Federal entities'' that ``expend'' 
federal funds exceeding a specified amount 11 in a 
given fiscal year. The single audit of all federal funds 
received by a non-Federal entity must be conducted by an 
independent auditor, in accordance with generally accepted 
government auditing standards. The single audit is then 
submitted to the OMB's Federal Audit Clearinghouse, from which 
the OMB prepares and submits an annual report to Congress 
regarding all such audits.
---------------------------------------------------------------------------
    \11\ Currently, the threshold is set at $500,000, as determined 
biannually by the Office of Management and Budget. This sum is the 
aggregate of all Federal awards in a given fiscal year.
---------------------------------------------------------------------------
    In Puerto Rico, the Arthur Anderson ``beneficiary'' audit 
of the school district's E-rate program projects--commissioned 
by USAC--did not identify the fiscal situation described by 
USDOE documents contained in the record. The documents, not 
directly related to the E-rate program, noted that ``large 
scale fiscal and accountability problems' in the district had 
existed for a number of years ``and appear to be continuing.'' 
12
---------------------------------------------------------------------------
    \12\ See E-rate Hearing, June 17, 2004, Committee on Energy and 
Commerce, Serial No. 108-92 (hereinafter referred to as Hearing, Part 
1) at 160. According to the FCC IG and USAC, current E-rate beneficiary 
audits require that auditors examine Single Audit findings, if they 
exist, to see if the findings affect E-rate program funding management; 
this requirement was not instituted until 2002. In May 2002, the USDOE 
had designated Puerto Rico a ``high risk grantee.'' The USDOE made this 
determination based upon information gathered through the Single Audit 
Act--the USDOE tabulated literally 300 findings that were unresolved 
and extended as far back as the mid-1990s. (The USDOE disburses roughly 
$1 billion annually to Puerto Rico through various programs.) As a 
result, the USDOE requested periodic progress reports from Puerto Rico 
as a precondition to receiving further education funding. While the 
findings did not directly address the E-rate program, they questioned 
financial controls and oversight by the school district that clearly 
might also impact the management and use of E-rate program resources. 
Based upon continued accountability concerns, the USDOE established 
``special conditions'' in August 2002, and began its own ``work-out'' 
plan with PRDOE.
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     The Puerto Rico Department of Education acquired goods 
and services through the E-rate program without using a formal 
bidding process, contrary to both the program's rules and the 
Commonwealth's regulations, and even though the district 
otherwise followed the E-rate program's Form 470 application 
process.
    According to Puerto Rico's Comptroller, the district did 
not adhere to formal bid procurement procedures in awarding E-
rate program contracts during Funding Years 1998 and 1999. 
Further, the Commonwealth's Office of Management and Budget 
failed to approve the E-rate program contracts in accordance 
with established rules. E-rate program rules require applicants 
to follow state and local bidding requirements, as well as the 
E-rate program's competitive bidding requirements. The 
Comptroller's audit findings showed that Puerto Rico had not 
done so. In contrast, USAC's outside auditor, Arthur Andersen, 
did not identify the irregular procedures. For example, Arthur 
Andersen reported that the Form 470 was filed properly and 
noted ``we ascertained through discussion with PRDOE management 
that they had established appropriate procedures to evaluate 
and select the most cost-effective bidder based on the 
responses to their 470 posting. PRDOE management also indicated 
that all bids received were appropriately evaluated in 
accordance with state and local requirements.'' 13 
Arthur Anderson evidently did not verify the district's 
assertions. Puerto Rico's broader problems, as identified by 
the Comptroller and the USDOE, show the limited utility of the 
Form 470 and Form 471 as the basis for competitive procurement 
and obtaining E-rate program funds.14
---------------------------------------------------------------------------
    \13\ See Hearing, Part 1 at 233.
    \14\ Arthur Andersen's failure on this front raises questions of 
the quality of the auditors' work. The FCC IG expressed such concerns 
in a memo to the FCC Chairman, criticizing both Andersen's work and 
USAC's acceptance of this work. See Hearing, Part 1 at 184 et. seq.
---------------------------------------------------------------------------
     PRDOE acquired E-rate program related goods and services 
without an adequate technology plan. More broadly, the E-rate 
program's current technology plan requirements provide no 
meaningful protection from gold-plating (over-procurement of 
goods and services, beyond the needs and resources of the 
school district).
    Under E-rate program rules, an applicant must certify that 
it has a technology plan that has been endorsed by its state, 
USAC, or an ``independent entity'' approved by the 
FCC.15 According to the FCC, this requirement 
ensures: (1) that schools and libraries prepare ``specific 
plans for using [E-rate program funded] technologies, both over 
the near term and into the future, and how they plan to 
integrate the use of these technologies into their curriculum'' 
and (2) that the technology plans ``are based on the reasonable 
needs and resources of the applicant and are consistent with 
the goals of the program.'' 16
---------------------------------------------------------------------------
    \15\ See 47 CFR 54.508(d).
    \16\ See FCC Order 97-157,  573-74.
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    Puerto Rico's then-Secretary of Education testified that no 
E-rate program related documentation, including the required 
technology plan, was located when his administration assumed 
office, suggesting that the prior administration, which was 
largely responsible for ordering the E-rate program goods and 
services, did not have an approved plan. USAC relied on Puerto 
Rico's certifications on the program's forms and did not review 
a technology plan, according to testimony.17 
Moreover, whether or not a technology plan existed and was 
approved, testimony, documents, and staff interviews all 
indicate that the E-rate program's technology-plan requirements 
have no real effect on what applicants actually request from 
the program. In short, the technology planning requirements, as 
shown by the excessive purchases in Puerto Rico and in other 
districts, are not effective and do not serve the intended 
purpose.
---------------------------------------------------------------------------
    \17\ See Hearing, Part 1 at 108-09. However, the Arthur Andersen 
audit reported reviewing a technology plan.
---------------------------------------------------------------------------
    Although USAC implementing procedures specify criteria that 
applicants must include in their technology plans, these 
criteria are not enforceable or necessarily effective in 
guarding against gold-plating. As the hearing showed, plan 
``approvers'' have no incentive to carefully monitor the 
substance and specificity of a technology plan, and USAC does 
not regularly refer to the plans when assessing applications. 
Moreover, the FCC did not codify the criteria that technology 
plans should cover until its August 2004 Fifth Report and 
Order, and even so, other weaknesses in technology planning 
still remain (infra, pages 31-32).
     The FCC IG cannot provide adequate assurance that the 
program is sufficiently protected against waste, fraud, and 
abuse. Furthermore, the FCC's Wireline Competition Bureau does 
not know the magnitude of potential fraud.
    According to hearing testimony and staff interviews, to 
date no statistically representative audit of the E-rate 
program has been completed to determine the extent of waste, 
fraud, and abuse. Without this critical information, the IG 
testified that he could not assure that the program could be 
protected against waste, fraud, and abuse. The deputy chief of 
the WCB also testified that the magnitude of potential fraud 
was unknown. (See GAO discussion below.)
    Further, the FCC IG testified that those audits that have 
been conducted and reviewed by his office raise several 
questions about the program's weaknesses. For example, 
according to an IG review of 135 E-rate program ``beneficiary 
audits,'' only 65 beneficiaries (schools and school districts) 
were determined to be compliant with program rules, 22 were 
determined to be ``generally'' compliant but with some problems 
identified, and 48 were not compliant and evidenced significant 
problems.18 Moreover, compliance with the rules does 
not necessarily mean the absence of audit ``findings'' 
questioning the integrity of the application process. In short, 
the type and magnitude of the problems found by this small 
number of audits suggests the need for a more thorough and 
systemic review of the universe of applicants.
---------------------------------------------------------------------------
    \18\ See ``Hearing on Problems with the E-rate Program: GAO Review 
of FCC Management and Oversight,'' March 16, 2005, Committee on Energy 
and Commerce, Serial No. 109-7, at 30.
---------------------------------------------------------------------------
     The FCC IG faces several obstacles in implementing 
effective independent oversight of the program. The IG 
testified that he lacks sufficient resources to conduct audits 
and provide audit support to law enforcement investigations.
    The FCC IG testified that his office would need 
approximately $12 million to hire the contractors to conduct 
approximately 240 audits, as well as to hire additional FCC 
staff to review the work. This would provide, according to the 
testimony, a statistically valid sample to enable the FCC IG to 
draw conclusions concerning the scope and nature of problems in 
the program.
    Under the program's current structure, the FCC cannot use 
funds from the USF to accomplish this oversight work. Congress 
would need to provide express statutory language authorizing 
the FCC or FCC IG to use E-rate program funds for audits and 
oversight of the E-rate program, or otherwise appropriate money 
for this purpose.
    It should be noted that at the time of this report's 
completion, the FCC IG and USAC are in the final stages of 
signing three-way contracts with outside audit firms to conduct 
statistically valid audits of all USF funding mechanisms. This 
would amount to an estimated 700 audits across the funding 
mechanisms and would likely provide sufficient statistical 
confidence to make determinations about the scope of waste, 
fraud, and abuse both in the E-rate program and Universal 
Service funding in general.19
---------------------------------------------------------------------------
    \19\ See Request for Proposals for Audit Services in Support of 
Oversight Program for the Universal Service Fund, USAC.
---------------------------------------------------------------------------
B. San Francisco Unified School District's E-rate Experience, and NEC 
        BNS
    On July 22, 2004, the Subcommittee held the second of three 
hearings entitled ``Problems with the E-rate Program: Waste, 
Fraud, and Abuse Concerns in the Wiring of Our Nation's Schools 
to the Internet.'' The Subcommittee considered the 
circumstances surrounding bid-rigging, inflated pricing, and 
the filing of false statements during the application process 
for E-rate program funding by San Francisco Unified School 
District (SFUSD). During Funding Year 2000, the competitive 
bidding process for SFUSD's E-rate program projects was 
completely corrupted, and the self-certification process 
failed. The Subcommittee also examined why USAC approved more 
than $48 million for a plainly fraudulent application, and how 
the school district superintendent, Dr. Arlene Ackerman, and 
others thwarted the scheme.
    SFUSD has about 60,000 students enrolled in approximately 
116 schools. During the first two years of the E-rate program, 
Funding Years 1998 and 1999, SFUSD applied for $3.5 million and 
$6.8 million respectively. By contrast, in Funding Year 2000, 
SFUSD submitted several E-rate program applications totaling 
$112 million. Of that total amount, two of the applications 
sought $106 million in internal connections discounts through 
two vendors--InterTel, Inc. ($23 million) and NEC BNS ($83 
million).
    During the applications' processing, USAC conducted its 
routine program integrity assurance (PIA) review. USAC also 
performed a ``selective review'' of the applications because of 
the magnitude of funds being requested. Subsequently, in 
September 2000, USAC committed $48.68 million to SFUSD for the 
products and services to be provided by NEC BNS and InterTel. 
While USAC approved this funding commitment, it neglected to 
perform the requisite due diligence despite finding certain 
irregularities in the SFUSD application, such as altered 
district budget documents.
    Shortly after Dr. Ackerman assumed leadership of SFUSD in 
August of 2000, she determined that there was something unusual 
about the school district's pending E-rate program 
applications, turned down the funding, and alerted the FBI. In 
April, 2001 Ms. Ackerman also requested that the San Francisco 
City Attorney investigate certain SFUSD employees, including 
Mr. Desmond McQuoid, who were involved with the suspect E-rate 
program applications. The City Attorney ultimately uncovered a 
nation-wide scheme to defraud the E-rate program, and filed a 
lawsuit under the False Claims Act against NEC BNS, VNCI, 
InterTel, and other parties involved with SFUSD's E-rate 
program application.
    On May 27, 2004, NEC BNS pleaded guilty to federal 
antitrust violations under Section 1 of the Sherman Act, and to 
wire fraud. As part of the plea agreement, NEC BNS agreed to 
pay $20.7 million in fines and restitution. According to both 
the plea agreement and the testimony provided by San Francisco 
officials before the Subcommittee, NEC BNS, VNCI, and InterTel 
established an agreement to circumvent competition for E-rate 
program projects by rigging the bidding process, submitting 
fraudulent bids, and predetermining who would win. Afterwards, 
the co-conspirators would submit Form 471s that grossly 
inflated the cost of the work (for example, SFUSD's Form 471 
was inflated by roughly $26 million), forging signatures and 
falsifying documents when necessary. Between December 1999 and 
March 2001, the co-conspirators used the bid-rigging scheme at 
several schools across the country. On December 8, 2004, the 
Justice Department announced that InterTel also pleaded guilty 
to similar federal antitrust violations under Section 1 of the 
Sherman Act, and to wire fraud. InterTel's agreement included 
fines and restitution totaling $8.7 million.20
---------------------------------------------------------------------------
    \20\ On April 7, 2005, VNCI, Judy Green, Allan Green, George 
Marchelos, and others were charged in a 22-count indictment with wire 
fraud, conspiracy, and various federal antitrust violations related to 
E-rate programs in more than 20 schools or school districts throughout 
the country. See United States v. Video Network Communications, Inc. 
(N.D. Cal.).
---------------------------------------------------------------------------
    For the July 22nd hearing, the Subcommittee subpoenaed four 
witnesses who had been invited but declined to voluntarily 
attend and testify. The individuals included: Mr. Thomas J. 
Burger, the President and CEO of NEC BNS; Mr. William Holman, 
the former Senior Vice President of Sales for NEC BNS; Mr. 
George Marchelos, a former E-rate consultant and VNCI employee; 
and Ms. Judy Green, also a former E-rate consultant and VNCI 
employee. While Ms. Green successfully evaded service by U.S. 
Marshals, the other subpoenaed witnesses appeared at the 
hearing and all of them invoked their Fifth Amendment rights 
against self-incrimination.
    On September 22, 2004, the first part of the Subcommittee's 
third E-rate hearing continued the examination of the NEC BNS-
related bid-rigging conspiracy. Testimony focused on other 
school districts that, unlike San Francisco, actually received 
E-rate program funded products and services through the 
conspiracy. The Subcommittee considered issues including: E-
rate program funding of ineligible goods and services; vendors' 
inappropriate use of ``in-kind'' donations to schools; school 
districts' obligations and responsibilities under program 
rules, including the mandatory requirement that schools 
contribute a co-payment to the cost of E-rate program projects; 
and, the role played by certain consultants in the conspiracy, 
as well as the role played by consultants in the E-rate program 
more broadly.
    Again, four witnesses who were invited to the hearing 
declined to attend and testify voluntarily, and the 
Subcommittee subsequently compelled their appearance through 
subpoenas. The individuals included: Ms. Judy Green, former E-
rate consultant and VNCI employee; Dr. Emma Epps, 
Superintendent of Ecorse Public School District; Dr. Douglas 
Benit, the former facilities director for Ecorse Public School 
District; and Mr. Quentin Lawson, the Executive Director of the 
National Alliance of Black School Educators (NABSE). At the 
hearing, Ms. Green and Mr. Lawson invoked their Fifth Amendment 
rights and declined to testify. Additionally, Mr. Carl Muscari, 
the President and CEO of VNCI, appeared voluntarily, but also 
chose to invoke the Fifth Amendment at the hearing.
    Testimony at the September 22nd hearing showed that both 
the Ecorse Public School District, in Michigan, and the Jasper 
County School District, in South Carolina, failed to pay their 
required co-payment to NEC BNS for the cost of their respective 
projects. NEC BNS and VNCI ``waived'' the school districts' co-
payments, despite clear FCC and USAC guidance that this was 
prohibited. Instead, the inflated funding requests on the Form 
471s were used to cover the schools' obligations. Additionally, 
both school districts' superintendents admitted that their 
schools received substantial in-kind donations of clearly 
ineligible goods and services. In the case of Ecorse, the 
Subcommittee examined documents and received testimony from an 
NEC BNS project manager that revealed that E-rate program funds 
paid for the construction of an $800,000 ``TV production 
studio'' at the district's high school. Testimony provided by 
USAC's Schools and Libraries Division Vice President, George 
McDonald, made clear that the TV studio and other in-kind 
donations were ineligible for E-rate program discounts and 
violated program rules. Neither the Ecorse nor Jasper County 
school officials were able to explain or justify the violation 
of the program's rules. Furthermore, in Ecorse, neither Dr. 
Epps nor Dr. Benit provided credible testimony about the 
funding of the TV studio or the school's failure to pay its co-
payment. Specifically, under questioning, neither school 
official could credibly explain several documents that showed 
Dr. Benit directing NEC BNS to allocate E-rate program funds to 
pay for the studio, other ineligible goods and services, and, 
implicitly, the school's mandatory co-payment.21
---------------------------------------------------------------------------
    \21\ For a complete accounting of Ecorse's allocation of E-rate 
funds, see E-rate Hearing, September 22, 2004, Committee on Energy and 
Commerce, Serial No. 108-124 (hereinafter referred to as Hearing, Part 
3) at 54-77. See also id. at 67 (Dr. Benit was not able to locate 
documents that supported his assertion that Ecorse School District paid 
NEC BNS its co-payment for the E-rate project).
---------------------------------------------------------------------------
    Finally, the September 22nd hearing examined the 
involvement of NABSE in the E-rate program, and its association 
with NEC BNS, VNCI, and other parties. For example, testimony 
showed that NABSE had an apparent contractual arrangement to 
provide potential E-rate program project leads to NEC BNS and 
VNCI through its large membership of school superintendents. 
Further, for every funded E-rate program project resulting from 
a NABSE lead, NABSE was slated to receive what amounted to a 
1.5% revenue return on all business related to the E-rate 
program. Despite Mr. Lawson's refusal to testify, a ten-minute 
NABSE E-rate program marketing video and documents entered into 
the record showed very active participation by NABSE officials 
in attempting to steer E-rate program related business to NEC 
BNS and VNCI.22 In fact, statements in the video and 
documents claim that NABSE's E-rate ``team'' had helped nine 
school districts receive a total of roughly $81 million in 
program discounts. The hearing showed that while NABSE held 
itself out to its members as simply being interested in 
ensuring that poor school districts were able to take full 
advantage of E-rate program funding, the organization actually 
held a financial stake in the process. USAC's George McDonald 
testified that any E-rate program funds that USAC determines 
actually went to NABSE inappropriately are subject to recovery 
actions. (To date, no attempts at recovery have been 
undertaken.)
---------------------------------------------------------------------------
    \22\ The NABSE video also refers to IBM as a member of the NABSE E-
rate ``team,'' but the investigation did not find evidence of IBM 
actually receiving business from NABSE efforts, and IBM officials 
testified that they had no knowledge of any such relationship.
---------------------------------------------------------------------------
Findings from the NEC-focused hearings and related investigation:
     USAC failed to reject the fraudulent SFUSD E-rate program 
applications, despite the fact that its employees identified 
several red flags and discrepancies, perhaps most notably among 
them an altered school district budget document.
    During the hearing, USAC Vice President George McDonald 
could not adequately explain why the forged budget document did 
not halt the program's application approval process for San 
Francisco. Mr. McDonald did note that the application 
reviewer's notes were not placed into a computer system, and 
that, at the time, ``novel'' issues were passed on to 
supervisors orally. Mr. McDonald did say that USAC has improved 
its review process since that time, compiling reviewers' 
observations in a database, and conducting quality assurance 
reviews of the reviewers. Mr. McDonald stated that he believed 
that today's reviewers would have been more diligent in 
investigating the budget forgery and notifying supervisors, and 
that USAC's approval would have been withheld. However, the 
hearing showed that Members remain concerned about ``rubber-
stamping'' of applications and inadequate scrutiny of the 
details and reasonableness of very large funding requests.
     The certifications contained on E-rate program 
application documents had little effect in deterring certain 
San Francisco school officials or the employees of NEC BNS, 
InterTel, or VNCI from forging documents and signatures and 
attempting to defraud the E-rate program.
    The certifications contained in E-rate program forms have 
failed to deter abuse by predatory vendors or irresponsible 
school officials. In December 2002, the FCC IG, in consultation 
with the Justice Department, provided the WCB with a series of 
recommendations to strengthen certifications, but, according to 
testimony and staff interviews with the Inspector General, the 
recommendations were largely ignored for more than 18 months. 
Only in 2004--six years into the program--did the FCC begin to 
propose changes in the certifications. Further, the FCC has not 
been comprehensive in its approach to strengthening the 
certifications. For example, the FCC's Chief of the WCB, Mr. 
William Maher, testified that the FCC was not considering 
requiring ``certificates of independent pricing,'' even though 
the Justice Department had suggested it, and Mr. Maher 
testified that he thought such a certificate would be a ``great 
idea.'' In the end, the hearing illustrated the weakness of 
certifications, to date, and the reticence of the FCC to 
promulgate certifications containing stronger criminal 
sanctions for acts of fraud and abuse, and greater deterrents 
to program predators--despite the sound advice provided by the 
Justice Department and endorsed by the FCC's IG.23
---------------------------------------------------------------------------
    \23\ See Hearing, Part 2, Tab 130.
---------------------------------------------------------------------------
     Employees of NEC BNS and VNCI completely manipulated the 
competitive process for E-rate program goods and services, and 
USAC did not discover the fraud.
    The hearing also illustrated some of the weaknesses 
contained in the E-rate program's competitive bidding 
requirements. The program's competitive bidding requirements 
should ensure the maximum value received by the applicant for 
the price paid, and reduce the risk of fraud and abuse. The 
Justice Department's certification memorandum also made 
suggestions regarding improving the competitive bidding 
environment.24 In answering questions at the hearing 
regarding those suggestions, Mr. Maher testified that 
establishing competitive bidding standards to ensure reasonable 
pricing, such as requiring a minimum number of bidders, posed 
``a difficult policy issue'' with which the FCC was 
``grappling.'' However, the WCB Chief could not answer how he 
thought an adequate competitive bidding process could be 
assured. Currently, one of the primary rules regarding 
competition simply requires a waiting period of 28 days between 
posting a Form 470 and entering into a contract. Program rules 
provide little guidance regarding exactly how E-rate program 
applicants should ensure competition, except to the extent that 
state and local procurement standards must be followed.
---------------------------------------------------------------------------
    \24\ Id.
---------------------------------------------------------------------------
     The E-rate program recently gained the option of 
debarring abusive vendors and applicants, but the rule 
established by the FCC is very limited in scope.
    Only since April 2003 has the program had access to the 
tool of debarment for purposes of deterring waste, fraud, and 
abuse, but the thresholds of conduct that trigger the 
``suspension and debarment'' process are set too high. 
According to the E-rate program's rules, an E-rate program 
participant may be barred from participating in the program for 
three years, but only upon a finding of criminal or civil 
liability. Debarment could be an effective tool for both 
holding program abusers accountable, and for deterring future 
abuse. However, the current rule does not address abusive or 
wasteful behavior that falls short of criminal or civil 
liability. For debarment to have a legitimate deterrent effect, 
and given that criminal or civil litigation may take several 
years to reach a judgment, the FCC's debarment standards should 
be more flexible, so that when an E-rate program participant 
considers abusing the program or intentionally exploiting 
program loopholes, it must also consider that the FCC has the 
power to address the participant's abusive actions.
     According to testimony, staff interviews, and criminal 
plea agreements to date, USAC and the FCC have dedicated 
insufficient attention and oversight to the activities of 
program consultants such as Judy Green, George Marchelos, VNCI, 
and NABSE.
    USAC and the FCC have not done enough to ensure that 
consultants play a fair and independent role in school 
districts' E-rate programs, that they have no financial stake 
in the outcome of the competitive bidding process, and that the 
E-rate program is not billed for those consulting services that 
are ineligible for E-rate funding. Testimony and documents from 
the NEC BNS-related hearings demonstrate how these 
``consultants'' either worked with willing and cooperative 
school officials to defraud the program, or used their greater 
knowledge of the program (or, in the case of NABSE, used its 
position of trust) to take advantage of overly-reliant school 
district personnel. According to testimony, documents, and the 
NABSE marketing video, employees of NEC BNS and VNCI in many 
cases had broad authority over decisions that should have been 
made by school officials. In other instances, such as in San 
Francisco, school district officials were extensively involved 
in the fraudulent procurements; in Ecorse, Michigan, school 
district officials were directly involved in highly 
questionable procurements. Further, the hearings examined 
documents showing a financial arrangement that NABSE had 
established with preferred vendors, such as NEC BNS and 
VNCI.25 However, staff found no information 
indicating that either the vendors or NABSE ever disclosed 
these contractual arrangements to NABSE's member school 
districts.
---------------------------------------------------------------------------
    \25\ Documents in the record only show payments made by VNCI to 
NABSE. While the letter purporting to establish an E-rate program 
partnership agreement was also signed by an IBM employee--Mr. Don 
Parker, a Customer Services Executive for IBM Global Services--who also 
appears in the NABSE E-rate program marketing video, the Subcommittee 
has no other evidence showing IBM's actual involvement with NABSE's E-
rate ``Team.'' IBM representatives testified, and a subsequent IBM 
letter submitted for the record declares (Hearing, Part 3, at 761-62), 
that Mr. Parker was not authorized to enter into any E-rate program 
teaming agreement with NABSE, and that IBM was not aware of the NABSE 
E-rate program video that suggests IBM's partnership with NABSE. 
Further, IBM's letter states that it has never made payments to NABSE 
in exchange for E-rate business referrals.
---------------------------------------------------------------------------
C. The Denial of $500 million in applicant requests associated with IBM
    During E-rate program Funding Year 2002, USAC rejected 
program funding requests from 21 school districts totaling 
approximately $517 million, due to a distinct pattern of 
program rule violations. In particular, USAC identified a 
pattern of procurement that violated the program's competitive 
bidding requirements. With minor variations, each school 
district engaged in a type of procurement that, according to 
the FCC, in affirming USAC's decision, ``effectively eliminates 
competitive bidding for the products and services eligible for 
discounts under the [E-rate] support mechanism.'' 
Notwithstanding the FCC's decision that the school districts 
violated E-rate program rules, the FCC permitted the rejected 
applicants who submitted appeals to resubmit their E-rate 
program applications for 2002 in accordance with proper 
procedures. The FCC reasoned that allowing reapplications would 
be in ``the public interest.'' 26
---------------------------------------------------------------------------
    \26\ See the FCC ``Ysleta'' Order, FCC Order 03-313, December 8, 
2003.
---------------------------------------------------------------------------
    Although the Funding Year 2002 ``boilerplate'' applications 
were noticed and denied by USAC, the identical bidding 
procedure had actually succeeded during the prior E-rate 
program Funding Year 2001, in El Paso Independent School 
District (EPISD), Texas. This urban school district--the 7th 
largest district in Texas, with 86 schools and approximately 
62,000 students--had participated in every year of the E-rate 
program. During the first three years, USAC approved $2.6 
million, $6.4 million, and $1.4 million, respectively, in 
program funding for El Paso. However, in Funding Year 2001, 
after EPISD selected IBM as a ``Strategic Technology Solutions 
Provider'' to integrate technology (including E-rate program 
funded technology) throughout the District, El Paso's E-rate 
program funding request swelled to more than $65 million.
    IBM has participated as an E-rate program vendor since the 
very start in 1998, and is the largest single recipient of the 
program's ``internal connections'' funding. Over the course of 
the program, IBM has received more than $832 million for E-rate 
related work. In Funding Year 2002, IBM was associated with 
more than $1 billion of E-rate program funding requests--almost 
double the value from the previous year.
    In El Paso, after the school district approved IBM as its 
``technology integrator,'' IBM provided El Paso with E-rate 
program ``statements of work'' for particular products and 
services, as well as the associated documents for the 
district's E-rate program application. These materials were 
prepared through Alpha Telecommunications (Alpha), IBM's E-rate 
program consultant. Without adequate analysis 27 or 
price competition for the products and services, El Paso 
submitted the documents provided by IBM as the basis of its E-
rate program application. With IBM serving as El Paso's primary 
program vendor, USAC approved $65.7 million in E-rate program 
funds in October 2001 for 52 schools. EPISD eventually spent 
$57 million of this amount, and also paid its $6 million co-
payment.
---------------------------------------------------------------------------
    \27\ See Hearing, Part 3, at 136.
---------------------------------------------------------------------------
    After USAC approved El Paso's E-rate program request, IBM 
aggressively marketed its ``systems integrator'' concept and 
promoted its work in El Paso as an example of how IBM could 
maximize E-rate program funds for other districts across the 
country, focusing primarily on IBM's ``West'' sales region. 
Documents in the record show that IBM supplied templates for 
school districts to use in making their requests for proposals, 
both for a strategic technology partner and for the E-rate 
program related services. IBM's marketing and the boilerplate 
E-rate program documents ultimately led to 21 school districts 
selecting IBM to coordinate their E-rate projects. Those 21 
contracts involved the previously mentioned $517 million in 
funding requests for Funding Year 2002, which USAC began to 
review in the spring of 2002.
    Meanwhile, in January 2002, USAC received an anonymous 
whistleblower letter that complained about IBM's role in El 
Paso and which prompted USAC to scrutinize the procurement 
process more closely. At that time, there was no indication on 
EPISD's funding request that it had engaged IBM as a strategic 
partner. USAC's investigation expanded to several other 
districts in 2002, and directly led to the denials for funding. 
USAC's investigation also determined that funds had been 
disbursed for ineligible services performed by IBM and its 
subcontractors.
    Of the 21 districts that were denied funding by USAC, nine 
districts (totaling $268 million in funds), appealed to the 
FCC. Additionally, IBM submitted its own appeals on behalf of 
eight of the districts. In December 2003, the FCC upheld USAC's 
decision regarding eight of the nine districts, but allowed 
them to re-submit applications for the funding year. The FCC 
sided with the remaining appellant--Winston-Salem School 
District, involving $16.7 million--determining that Winston-
Salem did not exhibit the same pattern that had triggered the 
other rejections.
    In light of the numerous applicants and the magnitude of E-
rate program funds involved, the Committee staff focused 
extensively on the facts and circumstances surrounding these 
IBM-related applications. Staff conducted interviews with 
school officials at districts that were denied funding, and 
particularly focused on the circumstances at the El Paso 
Independent School District. Committee staff conducted a site 
visit to EPISD in August 2003.
    On September 22, 2004, the Subcommittee's third hearing 
addressed information regarding the roles of the FCC, USAC, 
IBM, Alpha Telecommunications, and several school districts 
that worked with IBM in 2001 and 2002. The hearing examined the 
integrity of the E-rate program application process generally, 
and in particular, in the context of the IBM-related 
applications. The hearing also considered the specific 
circumstances leading up to and surrounding the denial of the 
Funding Year 2002 applications.
    The hearing presented a case study regarding the roles of 
vendors and of school districts in the E-rate program 
application process, and the propensity of schools and vendors 
to ``gold-plate'' the technology of the schools, far exceeding 
any reasonable educational technology needs. The hearing 
considered: 1) how IBM ``captured'' the E-rate program planning 
and procurement process at the schools by encouraging school 
districts to adopt the concept of a ``strategic integrator,'' 
and how this placed IBM in a conflicted advisor/vendor 
situation; 2) how vendors can ``bundle'' millions of dollars of 
ineligible goods and services, in effect removing them from 
USAC scrutiny; and 3) how weaknesses in the program were 
exploited by a large technology industry icon--as well as by 
school districts that were encouraged by the prospect of 
essentially paying only ten cents on the dollar for technology 
goods and services and of avoiding the difficult task of 
adequately planning for the integration of infrastructure, 
peripheral equipment, and teacher training with the technology 
purchased by E-rate program dollars.
Findings from the IBM-focused hearing and related investigation:
     Weaknesses in the E-rate program application process, 
including applicant certifications, allowed non-competitive 
procurement of E-rate related goods and services. The flawed 
application process resulted in the extravagant and wasteful E-
rate program funding in EPISD in Funding Year 2001, and nearly 
resulted in the waste of at least tens of millions of dollars 
more, among 21 other large school districts in Funding Year 
2002. Today, the FCC still allows anti-competitive or 
insufficiently competitive procurement practices. The program 
remains plagued with weaknesses in the application process, 
including vague or ambiguous rules regarding the requirements 
for competition.
    Competitive bidding for particular products and services 
sought by the applicants is fundamental to cost-effective 
procurement of goods and services. The program's minimal 
competition requirements and weak certifications do not ensure 
such price competition. Consequently, the program is highly 
susceptible to funding expensive, ineligible, and inappropriate 
products and services.
    The case in point is the El Paso Independent School 
District (and the attempts to mimic that paradigm around the 
country). Essentially, El Paso lacked any meaningful price 
competition for the goods and services requested by the 
District through the program. IBM was selected by the applicant 
in a two-step process that enabled the company to be the only 
service provider ``at the table'' when details of the goods and 
services were placed on the E-rate program application. In this 
instance, IBM made the most significant decisions regarding 
what services to request. As school district officials 
testified, district personnel had little time to review the 
application before it was submitted to USAC and relied ``too 
heavily'' upon IBM.28 In fact, IBM crafted portions 
of the E-rate project ``statements of work'' without even 
consulting with EPISD staff.
---------------------------------------------------------------------------
    \28\ See Hearing, Part 3, at 135.
---------------------------------------------------------------------------
    Whatever oversight the El Paso school district exerted 
before the E-rate program forms were signed and certified, the 
documents and testimony (as well as the templates used by IBM 
around the country) show that the service provider was guiding 
decision-making. This raises questions about the integrity of 
certifications that school officials must make. IBM and its 
consultant Alpha were able to bundle ineligible goods and 
services at excessive rates. For example, IBM did not specify 
in its invoices ineligible consulting services (i.e., Alpha's 
assistance in determining school discount eligibility and in 
preparing application forms and subsequent responses to USAC 
queries), which cost the E-rate program more than $4 million 
for El Paso alone. Alpha charged 7% for each E-rate program 
funded statement of work that it helped to prepare. This fee 
was actually rolled into the statements of work's final price 
tags.29 USAC explained that these services were 
ineligible for E-rate program funding. That is, if the school 
district had sought the services provided by Alpha separately, 
the E-rate program would not have covered the cost. Had similar 
IBM-associated applications for Funding Year 2002 been 
approved, the program would have paid out an even larger sum 
for these ineligible consulting services. Further, the 
consulting fees amount to just one part of more than $20 
million in wasteful E-rate program spending in El Paso.
---------------------------------------------------------------------------
    \29\ In a truly competitive bidding process, this additional 7% 
``fee'' would have likely made IBM less competitive in each of its 
bids.
---------------------------------------------------------------------------
    Fortunately, USAC was able to identify the anti-competitive 
practices and deny the ``technology integrator'' pattern of 
applications in 2002. Subsequently, the FCC and USAC did 
clarify rules and procedures regarding price competition in the 
aftermath of these denials. However, underlying problems in the 
process still remain. The FCC IG testified that IBM-related 
applications highlight the IG's concern about weaknesses in the 
rules governing competition for E-rate projects. One 
fundamental weakness in this regard is the reliance on the Form 
470 as the basis of competition. The FCC IG testified that the 
current E-rate program competitive process is based upon the 
faulty assumption that by posting a Form 470 on USAC's Web site 
for 28 days--as the current rules require--healthy and rigorous 
competition will occur. The FCC IG further testified that its 
audits indicate that this ``frequently does not happen.'' 
Simply put, the Form 470 is too general for vendors to discern 
project parameters and build robust, highly competitive bids 
that meet the schools' needs, and therefore frequently fails to 
generate the level of competition envisioned for the program. 
The hearing testimony demonstrated that school officials often 
fail to carry out their obligations to the competitive 
process--for example, neglecting to provide interested vendors 
with answers to questions about a given RFP.30
---------------------------------------------------------------------------
    \30\ See Hearing, Part 3, at155-57.
---------------------------------------------------------------------------
    Additional testimony illustrated that school districts 
often already have vendors in mind when they post the Form 
470s, or otherwise fail to respond to legitimate vendor 
inquiries. This weakness provides some vendors with an 
opportunity to insert themselves, inappropriately, into a 
school's planning process. As one witness testified, service 
providers ``prey upon applicants that have no knowledge of the 
program but are told this service provider can get them money 
for computers.'' 31 Testimony and documents suggest 
that vendors have improperly sought advance commitments from 
school officials. For example, documents in the record showed 
IBM seeking ``verbal commits'' during the posting of RFPs and 
the Form 470. USAC testified that if the verbal commit occurred 
before the posting of the Form 470, that it would violate E-
rate program rules.32
---------------------------------------------------------------------------
    \31\ Id.
    \32\ Id. at 46.
---------------------------------------------------------------------------
    Additionally, certifications made by school officials on 
applications may not be sufficiently strong to deter false 
claims and statements, and ultimately prevent waste, fraud, or 
abuse. The FCC IG testified that reliance on beneficiary 
``self-certification'' is a serious vulnerability because the 
program uses these signatures as a primary bulwark against 
improper funding requests. Without an ability to police these 
certifications and punish false statements, this flaw opens an 
avenue for waste and abuse. There have been no false statement 
charges asserted in the criminal indictments, to date, or that 
are being pursued by ongoing federal investigations, as 
reported by the FCC IG.33 The FCC IG testified that 
the FCC waited until September 2004 to begin to address some of 
the Justice Department's December 2002 recommendations 
regarding the certifications.
---------------------------------------------------------------------------
    \33\ Id.
---------------------------------------------------------------------------
     El Paso and other school districts involved in the IBM-
related ``strategic integrator'' applications demonstrate that 
the current E-rate program application approval process cannot 
either prevent ``gold-plating,'' which far exceeds the 
reasonable needs of a school district, or ensure the cost-
effective delivery of E-rate program goods and services. In 
fact, the program's current structure may actually encourage 
gold-plating.
    The Subcommittee's work unearthed a number of vivid 
examples of wasteful and excessive spending. For example, the 
El Paso application persuaded USAC to fund a $27 million, 
state-of-the-art network maintenance support center for 53 of 
the district's poorest schools to keep the network ``up and 
running.'' 34 As troubling, the $27 million 
maintenance center only operated for three months before the 
funding year ended. Even though IBM billed USAC and the 
district for the full $27 million, most of the funds were 
dedicated to the design and set up of the maintenance center. 
Further, the set-up costs involved included ineligible 
inventory surveys, high-level design and planning, and leasing 
and construction of an off-site call center.35 In 
the end, the help desk possessed so much capacity that IBM 
sales staff considered using it to support other school 
districts.36
---------------------------------------------------------------------------
    \34\ Id. at 246.
    \35\ Documents in hearing record reveal funding for maintenance 
support covered more than ``basic maintenance.'' See Id. at 478-79, 
556-57, 561-65.
    \36\ Email subject line ``TSO Support Multiple ISD,'' from Milota 
to Diaz et. al, of IBM, July 18, 2002. (This document is stored at the 
Committee on Energy and Commerce.)
---------------------------------------------------------------------------
    At the hearing, EPISD's superintendent testified that the 
district did not get its money's worth from the partnership 
with IBM. Moreover, documents show that the maintenance system 
placed an enormous burden on the district's resources, 
prompting El Paso to redirect some of its staff to assist with 
the help desk. For all the 2001 E-rate project's promise, the 
district technology director became concerned that the district 
had ``bit off more than it could chew,'' and documents and 
testimony show that he had difficulty articulating the value of 
the maintenance center to the school board.37 When 
USAC rejected the district's E-rate program application for 
Funding Year 2002, IBM removed the associated-equipment and 
closed the center--to the surprise of the school district--and 
left the school to manage on its own, on roughly a $2 million 
annual technical maintenance budget--or about 7% of the IBM 
maintenance support funding.38 It should be noted 
that no technical assistance relating to the problems with 
computers, printers, or other non-E-rate program equipment were 
eligible under this maintenance support. Most technical 
problems with E-rate program eligible equipment should have 
been provided for under the standard warranties that IBM and 
other equipment vendors provide purchasers. It is no 
exaggeration to claim that virtually the entire $27 million 
maintenance operation was ineligible.
---------------------------------------------------------------------------
    \37\ See Hearing, Part 3 at 560, 570.
    \38\ IBM testified that its maintenance costs were high because the 
District was moving from essentially no maintenance infrastructure to 
the set up of ``a large, complex system.'' Actual maintenance and 
``help desk'' support represented only a portion of the total costs. 
See Id. at 260, 261.
---------------------------------------------------------------------------
    Another example of waste may be found in the failure to 
prevent excessive and redundant acquisition of E-rate program 
goods and services. In El Paso, the scope of work was drafted 
by IBM to include all 86 schools in the district, not the 53 
that were eligible for funding. Yet the district made no change 
in the scope of work applied for, and thus received funding for 
an additional 33 schools. In the Dallas Independent School 
District (DISD), IBM planned and priced the E-rate program 
related work for all of the district's 245 
schools.39 Documents and testimony indicate that, as 
a result, the initial request to USAC for $216 million for the 
district's 155 eligible schools was excessive. The Dallas 
School District official responsible for the project testified 
that when he reviewed the application, he was able to cut about 
$86 million in duplicative products, services, and support. 
Overly duplicative applications were also part of the broader 
pattern of applications associated with IBM in Funding Year 
2002. Documents in the record indicate that IBM recommended 
(and drafted into its statements of work for each applicant) 
``stand-alone'' E-rate projects that had maintenance and other 
installation services actually built into the cost, in the 
event that other maintenance projects were rejected. This 
approach led to large, redundant requests that inflated the 
cost.
---------------------------------------------------------------------------
    \39\ Id. at 617.
---------------------------------------------------------------------------
     E-rate program technology plan requirements and resource 
requirements for school districts insufficiently guard against 
waste, fraud, and abuse.
    EPISD maintained that the $27 million maintenance operation 
and $30 million worth of other E-rate program related work was 
consistent with the district's technology plan. However, that 
technology plan--as is generally the case for E-rate program 
technology plans--was insufficient to prevent waste, fraud, and 
abuse. In fact, the initial $70 million in funding requests was 
made under the technology plan used by the EPISD the previous 
three years, when the school district received E-rate program 
funds averaging $3.4 million per year. The plan provided no 
meaningful measures to ensure that the goods and services 
purchased were reasonably connected to the school district's 
needs and abilities. Significantly, USAC's guidance on 
technology plans notes that ``it is only necessary that the 
approved plan include a sufficient level of information to 
justify and validate the purpose of a Universal Service Program 
request. However, it does not have to include the specific 
details and information called for on FCC Forms 470, 471, and 
486 [request to commence invoicing].'' 40 Moreover, 
USAC does not review plans as part of its normal application 
review process. The FCC in its August 2004 Fifth Report and 
Order declined recommendations to require such review, ``for 
administrative efficiency.'' Given weaknesses in content and 
timing of plan preparation--the FCC only ``expects,'' not 
requires, that plans are prepared prior to posting a Form 470. 
41
---------------------------------------------------------------------------
    \40\ See USAC technology plan guidelines at 
www.sl.universalservice.org
    \41\ See FCC Fifth Report and Order and Order, August 2004,  56, 
62.
---------------------------------------------------------------------------
     The program does not ensure that schools and teachers 
have chosen goods and services they actually need.
    Despite spending more than $60 million in E-rate program 
funds, as well as its own money, for services and upgrades to 
its telecommunications infrastructure, El Paso was actually 
reducing its focus on integrating technology into the 
classroom. In the first three years of the program, the 
District's head of instructional technology, Ms. Sharon Foster, 
coordinated E-rate program applications. When Ms. Foster 
departed, E-rate program management was completely shifted to 
the technology department, which, by all available information 
to the Subcommittee, neglected to coordinate with the 
instructional needs of teachers. Indeed, during an August 2003 
site visit, Subcommittee staff learned that in the year leading 
up to and following installation of the Funding Year 2001 
project, El Paso effectively eliminated eight to ten ``Campus 
Technology Coordinators.'' In short, the district eliminated a 
key element for coordinating training and curricula needs with 
the E-rate program application for goods and services. 
Consequently, high-quality gear and services were not being 
fully utilized more than a year after the systems were 
installed.
    Hearing testimony by Ms. Foster also provided a broader 
perspective to the issue. That is, absent a direct link to the 
instructional needs of the students, school districts that have 
been driven by vendor influence have ``asked for too much too 
quickly and were not in the best position to fully support 
technology projects for which funding was awarded.'' 
42 ``In short,'' she said, ``staff development, like 
the funding for network and technology projects, must be on a 
consistent, realistic, multi-year basis.'' 43 With 
these weaknesses in technology planning and application 
certifications the E-rate program lacks an effective and 
reliable mechanism for ensuring that E-rate program funding 
requests are driven by instructional need.
---------------------------------------------------------------------------
    \42\ See Hearing, Part 3 at 154.
    \43\ Id.
---------------------------------------------------------------------------
     Unclear rules and program procedures and delays in 
program funding generate confusion among applicants and 
vendors, and are a source of waste.
    Testimony by E-rate program vendors and school district 
officials provided an important perspective regarding the E-
rate program's rules and operation. First, substantial 
confusion regarding goods and services eligibility and the 
interpretation of vague rules and procedures contributes to 
waste and abuse. Notably, the FCC essentially acknowledged this 
confusion in its ``Ysleta'' Order regarding Funding Year 2002. 
Furthermore, the ambiguity of program rules also provides an 
incentive to vendors and consultants to take advantage of 
school districts that have either not necessarily planned for 
the E-rate program adequately, or that are not equipped with 
``technology-savvy'' staff.
    Second, the structure of the E-rate program funding cycle, 
with its very large time span between when an application is 
submitted and when it is funded, does not efficiently fit into 
the typical school district's budget and planning cycles--an 
issue the Committee staff observed in many school districts. 
This disconnect between typical school operations and the 
program's funding process generates waste, because districts 
must either scramble to spend the funds before the program's 
implementation deadlines, or apply for E-rate program funds 
before other resources have been budgeted and secured. 
According to testimony, school districts that are burdened by 
limited planning in the first place may struggle to manage the 
overlapping phases of three E-rate program funding years that 
may be occurring at any one time. This inherent program 
confusion and delay contributes even more complexity to the 
effective implementation, management, and oversight of the 
program, from the perspective of the applicants, USAC or the 
FCC.
D. E-rate Related Investigation of Chicago Public Schools
    The Subcommittee's E-rate program oversight hearings were 
largely focused on the programmatic flaws and concerns with the 
program's ``front end'' application process. Significantly, our 
work has determined that the E-rate program also encountered 
problems during the ``implementation'' stage of the funding 
process--that is, the period of time when E-rate program goods 
and services are provided, and the funds actually are spent.
    Subcommittee oversight of Chicago Public Schools' (CPS) 
participation in the E-rate program, and CPS' relationship with 
the school district's program manager, SBC Telecommunications 
(SBC) 44, helped to illuminate some of the major 
pitfalls of E-rate program implementation. In Chicago, the 
school district created an environment that encouraged program 
fund mismanagement by both the school and the primary E-rate 
program contractor, SBC, and led to the improper stockpiling of 
$8.5 million in internal connections equipment, much of which 
included expensive electronic switches that never left 
distribution warehouses.45
---------------------------------------------------------------------------
    \44\ See Investigation Report by Mayer, Brown, Rowe & Maw LLP, 
dated January 14, 2004 (Mayer Brown Report) at 21. (The Report is 
stored at the Committee on Energy and Commerce).
    \45\ Id. at 2 and 35.
---------------------------------------------------------------------------
    CPS is one of the largest school districts in the country, 
with nearly 600 schools and 435,000 students. CPS has received 
over $236 million in E-rate program discounts since the 
program's inception, and according to the district has spent 
over $600 million of non-E-rate funds on infrastructure 
improvements necessary to prepare the schools for the internal 
connections funded by the E-rate program.46 Chicago 
became one focal point of the investigation as a result of 
Committee letters sent during July 2003 to 14 E-rate program 
vendors, including several SBC operating units.
---------------------------------------------------------------------------
    \46\ See Investigation Report by Hogan & Hartson LLP, dated August 
16, 2004 (Hogan Report) at 1. (The Report is stored at the Committee on 
Energy and Commerce.)
---------------------------------------------------------------------------
    During the course of the Committee's work, staff visited 
school districts across the country to observe first-hand how 
the E-rate program was actually being implemented. Among the 
site visits were two trips to Chicago, one in early December 
2003 and the other in late August 2004, during both of which 
staff conducted interviews of the relevant employees of SBC and 
CPS. Staff had scheduled a December 11, 2003 site visit to 
Chicago, and on December 9, 2003, SBC's Washington, D.C. office 
contacted staff to alert the Committee regarding a then-current 
stockpile of $5 million worth of E-rate program related 
inventory sitting unused in three Chicago warehouses. Committee 
staff later ascertained that SBC officials in Chicago had 
knowledge of the stockpiled equipment at least since early 
2001, when more than $8 million sat in inventory. There is no 
evidence indicating that SBC's knowledge extended beyond the 
Chicago office. Staff also determined that school district 
officials were aware of the inventory at least as early as 
April 2002. Staff further learned that SBC had been reimbursed 
by USAC for this unused equipment.
    Also in December 2003, SBC tasked the law firm Mayer, 
Brown, Rowe & Maw LLP (``Mayer Brown'') to conduct an internal 
investigation regarding the improper stockpiling and billing of 
USAC for the equipment. On January 14, 2004, the Committee 
issued a second letter to SBC requesting further details and 
documentation of the E-rate program in Chicago, and 
particularly the circumstances surrounding the equipment 
stockpiling. In mid-January 2004, Mayer Brown completed its 
investigation, and SBC provided a copy of the firm's report to 
the Committee.47 The Mayer Brown Report concluded 
that SBC had violated program rules and that the company was 
required to return $8.8 million to the E-rate program. On 
January 16, 2004, SBC submitted a payment of $8.8 million to 
USAC. Subsequently, in late January 2004 the Committee 
requested further documents and information from the school 
district regarding its participation in the E-rate program, and 
specifically regarding the inappropriate stockpiling. CPS hired 
outside counsel, the law firm Hogan & Hartson LLP (``Hogan''), 
which conducted an investigation and prepared a report of its 
own. CPS provided the Committee a copy of the report on August 
16, 2004.48
---------------------------------------------------------------------------
    \47\ See Mayer Brown Report.
    \48\ See Hogan Report.
---------------------------------------------------------------------------
    During Funding Year 1999, USAC approved CPS' request for 
$66 million for internal connections projects in July 
1999.49 CPS awarded a contract for management of the 
E-rate program project to SBC, which had specifically held 
itself out to CPS as having an expertise in project 
management.50 Due to a number of issues, including 
inconsistent decisions by CPS administrators and poor planning, 
as well as lengthy USAC funding-decision delays, CPS faced a 
severe time crunch for fully implementing the $66 million 
project before the funding year's deadline of September 
2000.51 Consequently, CPS instituted a ``Fast 
Track'' plan between June and September of 2000 to accomplish 
basic Local Area Network (LAN) 52 construction in as 
many schools as possible before the deadline.53 That 
decision ultimately led SBC and its subcontractors to bulk 
purchase and stockpile large quantities of internal connections 
equipment, including several hundred Cisco 
switches.54 SBC submitted invoices and was 
reimbursed for this equipment, much of which had not been 
installed, violating E-rate program rules.55
---------------------------------------------------------------------------
    \49\ See Mayer Brown Report at 27.
    \50\ See Hogan Report at 23. See also Mayer Brown Report at 21.
    \51\ Id. at 27-32. See also Hogan Report at 31-38.
    \52\ A LAN is generally defined as: ``A system that links together 
electronic office equipment, such as computers, and forms a network 
within an office or a building.'' (Webster's II New College Dictionary, 
3rd Ed., Houghton Mifflin Co., 2005). An ``Ethernet'' is one example of 
a LAN.
    \53\ See Mayer Brown Report at 32-33.
    \54\ Id. at 35-38.
    \55\ Id. at 39. In general, after a school certifies to USAC on an 
E-rate Form 486 that the applicant ``is receiving, is scheduled to 
receive, or has received service'' from the vendor, USAC will reimburse 
the vendor upon receipt of the vendor's invoices. Subsequently, the 
vendor may submit a Form 474 (``service provider invoice''), informing 
USAC the amount of E-rate program funds owed to the vendor for the work 
performed. While the vendor indicates either the date it billed the 
school district for the work or the date that it completed the E-rate 
program related work, there is no requirement for the vendor to provide 
detailed billing information or supporting documentation.
---------------------------------------------------------------------------
    In April 2002, SBC and its major equipment supplier, Cisco, 
prepared an E-rate program related work proposal for marketing 
to Chicago Public Schools a ``refresh'' of the uninstalled 
switches. SBC and Cisco described the warehoused switches to 
CPS as being ``obsolete.'' 56 The SBC/Cisco switch 
refresh required that the school district return the ``old'' 
unused switches for a minimal discount against the cost of the 
new switches.57 Thus, CPS and the E-rate program 
would essentially pay twice for equipment that had never been 
installed into the school district's networks.58 
Under E-rate program rules and procedures, USAC would have 
simply approved the funding request for the new switches from 
CPS--as long as the request form was correctly filled out, 
submitted, and certified. At the time, USAC had no safeguards 
to prevent this sort of ``refreshing'' of otherwise usable 
equipment, or for detecting duplicative equipment requests.
---------------------------------------------------------------------------
    \56\ See Mayer Brown Report at 44. According to staff interviews of 
Cisco employees, however, the switches were far from obsolete, either 
in terms of their usefulness or the last date for which service support 
would be available.
    \57\ Id. at 45.
    \58\ Id.
---------------------------------------------------------------------------
    In sum, the Chicago Public Schools case study highlights 
management and implementation problems that may be encountered 
when carrying out a very large and expensive E-rate program 
internal connections project over multiple years. The extended 
delay by USAC in making a funding commitment to Chicago Public 
Schools led the school district to make key project decisions 
that further compounded implementation issues. Furthermore, the 
case study highlights the limitations of USAC to effectively 
oversee the implementation of such complex projects.
    Additionally, then-Chairman Tauzin and then-Subcommittee 
Chairman Greenwood requested further documents and information 
from SBC regarding its participation in the E-rate program in 
other regions of the country. SBC responded to the Committee's 
request, providing information to the Committee regarding: (1) 
an SBC Connecticut sales employee who discussed with school 
officials the possibility of inflating SBC's bid costs, so that 
sufficient margin would be available to cover Bridgeport Public 
School's co-payment; (2) SBC Ohio personnel who offered to 
provide Cleveland Municipal Public School District an interest-
free loan to cover its co-payment, which the school rejected 
after its attorneys determined that such a transaction would 
violate E-rate program rules; and (3) an SBC refund to SLD of 
$1.4 million in E-rate program funds from Funding Year 2003 
that had been spent on ineligible services in New London, 
Connecticut.59 In the Connecticut instance, SBC 
later entered into a consent decree with the FCC in which SBC 
made ``a voluntary contribution to the United States Treasury 
in the amount of five hundred thousand dollars'' in addition to 
the $1.4 million that it had refunded to the SLD.60 
SBC also agreed to implement an extensive E-rate training and 
compliance program for its employees, designate regional E-rate 
program coordinators throughout the company, and create its own 
internal E-rate program oversight structure.61
---------------------------------------------------------------------------
    \59\ See Letter from SBC to the Committee on Energy and Commerce, 
dated August 6, 2004. (The document is stored at the Committee on 
Energy and Commerce.)
    \60\ See FCC/SBC Consent Decree, adopted December 14, 2004.
    \61\ Id.
---------------------------------------------------------------------------
Findings from the Chicago Public Schools related investigation:
     The timing of the E-rate program application, review, and 
approval process makes implementation of large internal 
connections projects, such as at Chicago Public Schools, 
particularly vulnerable to waste, fraud, and abuse.
    Because of the very long delays in funding decisions by 
USAC, CPS faced the dilemma of spending $66 million for Funding 
Year 2000 in only a matter of months. (In fact, during the 
course of the investigation, the Subcommittee frequently came 
upon instances in which school officials and their vendors 
found themselves with large sums of E-rate program funds being 
approved late in the program funding cycle and very little time 
to utilize those funds before the deadlines.) In late July 
2000, the CPS Board and CEO directed Ms. Elaine Williams (the 
head of the school district's Office of Technology Services), 
against her recommendation to return unspent funds to USAC 
62, to spend $54 million by September 30, 
2000.63 This gave rise to the decision to implement 
the Fast Track program, setting off a chain of events that led 
to advance purchases of large amounts of equipment by SBC's 
distributors, and ultimately to the stockpiled surplus. Indeed, 
the SBC project management team in Chicago believed that the 
lynch pin to completing the work and utilizing the funds by the 
program deadline was materials procurement.64
---------------------------------------------------------------------------
    \62\ It is not necessarily the case that CPS or any other school 
district that did not spend the entire committed amount in a given 
Funding Year would lose those funds. In the first instance, applicants 
have the opportunity to submit a request for an extension of time to 
complete the E-rate related project. Furthermore, USAC would likely 
approve a new application, for the following Funding Year, to complete 
the work that it had previously authorized.
    \63\ See Mayer Brown Report at 34.
    \64\ Id. at 35.
---------------------------------------------------------------------------
    SBC and CPS agreed that bulk purchase of key materials, 
including ``long-lead-time'' components, was indeed the 
solution, and on July 20, 2000 CPS authorized SBC to make the 
bulk purchases.65 Among other steps, SBC placed a 
purchase order with each of its three distributors for a total 
of $24.5 million, based upon a generic ``template design'' for 
wiring all of the schools.66 SBC also placed a $3 
million open purchase order with each distributor ``to cover 
the materials needed for the Fast Track installations for both 
E-rate Year 2 and Year 3 which . . . had an identical scope of 
work and an overlapping three-month period.'' 67 
According to one SBC program manager, contractors may have 
deliberately ordered excess materials to prevent any 
delays.68 Ultimately, the Mayer Brown investigation 
determined that the initial Fast Track invoices were not based 
on actual shipments to schools, but rather were `` `pre-bills' 
for materials that were not yet shipped, but merely ordered or 
to be ordered by the distributors.'' 69
---------------------------------------------------------------------------
    \65\ Id. at 36.
    \66\ Id.
    \67\ Id.
    \68\ Id.
    \69\ Id. at 37.
---------------------------------------------------------------------------
    Further procurement confusion grew from a three-month 
overlap in E-rate program Funding Years 1999 and 2000, as well 
as from the fact that the ``scope of work'' for CPS' LAN 
project was identical for each year.70 According to 
the Mayer Brown Report, this may have fostered ``a lack of 
rigor among project personnel in failing to assure that all 
work funded with E-rate Year 2 SLD dollars was completed by the 
Year 2 implementation deadline, rather than being allowed to 
spill over into E-rate Year 3, and beyond.'' 71
---------------------------------------------------------------------------
    \70\ Id. at 32.
    \71\ Id.
---------------------------------------------------------------------------
    Building upon the unintended consequences, SBC's three 
distributors purchased directly from the switch vendor, Cisco, 
rather than through the program manager, SBC.72 
Thus, ``SBC had to pay the standard, non-discounted prices for 
the Cisco network equipment that its distributors had 
purchased, rather than the 35% bulk-rate discounts that would 
have been available on Cisco equipment had SBC ordered the 
equipment directly from Cisco.'' 73 Indeed, at a 
June, 2003 ``Inventory Issues Meeting'' between CPS and SBC, 
the meeting minutes state:
---------------------------------------------------------------------------
    \72\ SBC is one of Cisco's industry ``channel partners,'' and as 
such Cisco extends a substantial discount to SBC on its equipment 
purchases.
    \73\ See Hogan Report at 40.
---------------------------------------------------------------------------
        when CPS questioned why the amount paid for the 
        original Cisco equipment (switches) was so large 
        (approximately $4 million), SBC stated that they paid 
        full price for the Cisco materials. SBC could not 
        obtain a discount, as is customary, because they 
        ordered the Cisco Equipment from distributors. The 
        discount can only be obtained if the order is placed 
        directly through Cisco (material ordered directly from 
        Cisco is discounted at 35%). SBC stated that there was 
        not enough time to place the order directly with Cisco 
        because of the time constraint imposed by the September 
        30 deadline.74
---------------------------------------------------------------------------
    \74\ See Mayer Brown Report at Tab 30, at 9.
---------------------------------------------------------------------------
    Finally, with regard to the implementation phase of very 
large E-rate program projects, there is no commensurate 
oversight by the FCC or USAC after applications for funds are 
approved for disbursement. As a case in point, USAC's Arthur 
Anderson beneficiary audit of Funding Years 1999 and 2000 at 
Chicago Public Schools completely failed to identify the $8.5 
million in uninstalled inventory that USAC had funded. Instead, 
the audit identified some other billing and invoice 
discrepancies, which ultimately prompted CPS to hire its own 
auditor, KPMG. KPMG resolved many of the problems identified by 
Anderson, but also identified the deeper problems of program 
management detailed above.
     SBC and CPS failed to effectively plan, manage, and keep 
accurate records, and failed to resolve problems in a timely 
manner, which led to considerable waste.
    The SBC project management team in Chicago failed to 
understand the E-rate program's rules. According to the Mayer 
Brown Report, ``[e]mployees involved with the CPS E-rate 
Program had not received adequate training with respect to 
contractor obligations in a federally-funded program. This lack 
of training with respect to the unique obligations imposed 
under such a program resulted in the employees inappropriately 
relying on exchanges of e-mails with a federal agency for 
interpretation of federal regulatory requirements . . .'' 
75
---------------------------------------------------------------------------
    \75\ Id. at 3.
---------------------------------------------------------------------------
    SBC's account team lacked training regarding the issues 
surrounding the receipt of federal funds.76 The SBC 
``management team received no formal E-rate training, nor 
training on regulatory compliance . . .'' and the individuals 
in charge of that team ``had no prior experience in managing E-
rate projects or contracts involving federal funds.'' 
77 For example, SBC's ``program executive'' for the 
Chicago E-rate project lacked any experience on federal 
government contracts or E-rate program projects prior to her 
leadership of the CPS LAN project.78
---------------------------------------------------------------------------
    \76\ Id. at 26.
    \77\ Id.
    \78\ Id.
---------------------------------------------------------------------------
    The Mayer Brown investigation found that ``at least by the 
end of 2000, SBC personnel were aware of the general 
requirement that materials be `delivered and installed' in the 
E-rate year in which the materials were purchased.'' 
79 SBC's subcontractor, TeamWerks, when told in 
writing by the SLD that it was against the rules to bill for 
``work'' not installed by September 30, 2000, characterized 
that guidance as ``quite ambiguous'' because the SLD had made 
no reference to ``materials.'' 80 Ultimately, SBC 
decided to roll forward the Funding Year 2000 inventory to 
Funding Year 2001--despite its knowledge of the rules requiring 
delivery and installation--based upon a tenuous distinction 
between ``returned'' excess inventory and excess materials that 
had never left warehouses.81 Further, SBC project 
leaders were willing to rely on an old and vague e-mail message 
from April 2001 to support their actions.82
---------------------------------------------------------------------------
    \79\ Id. at 54.
    \80\ Id. at 55.
    \81\ Id. at 56.
    \82\ Id. at 1-2. When KPMG first learned of the April 2001 e-mail 
to the SLD, it described the question as ``misleading''--``apparently 
because it used the words `some inventory' instead of disclosing the 
amount.'' Id. at 48.
---------------------------------------------------------------------------
    The school district also was responsible for the spate of 
program management problems. In order to ensure sufficient 
electrical power support for the LAN project, CPS undertook an 
electrical service upgrade at the same time as the LAN 
implementation.83 CPS chose to execute both projects 
simultaneously, through a single contractor leading both 
efforts--even though the electrical infrastructure upgrades 
were not E-rate program eligible. As a result, ``the LAN 
installation and power upgrade work contributed to a convoluted 
organizational structure for the overall project.'' 
84 Furthermore, SBC did not report directly to the 
school district. Instead, a consulting firm named Chicago 
School Associates (CSA) was hired by the district to manage the 
LAN installation and power upgrade general contractors, 
including SBC, so SBC's project team reported to the Director 
of Program Management at CSA.85
---------------------------------------------------------------------------
    \83\ Id. at 28.
    \84\ Id.
    \85\ Id.
---------------------------------------------------------------------------
    The school district made several other decisions that 
hampered project planning and efficiency, including, among 
others: 1) CPS had 250 schools that had separately applied for 
Funding Year 1999 E-rate funds, and which were outside the 
scope of the CPS-SBC agreement, but which still required E-rate 
program work to be accomplished; 2) the LAN project was 
initially supervised by the district's Capital Improvements 
Department, not by the Office of Technology Services where the 
knowledge of the E-rate program and the LAN project actually 
resided; 3) the Capital Improvements Department generated its 
own LAN designs for the schools, despite the lack of necessary 
technical expertise, resulting in the majority of the designs 
being rejected by SBC and its network architect; 4) CPS 
required SBC to seek combined LAN/power upgrade bids from 
subcontractors 86; 5) CPS failed to promptly issue 
SBC a ``notice to proceed,'' further constraining the time 
available to fully utilize E-rate program funds before the 
funding deadline; 6) CPS delayed providing SBC specific school 
assignments for E-rate program LAN work; and 7) CPS frequently 
made revisions to the list of schools at which SBC needed to do 
E-rate program work. These sorts of choices ultimately end up 
costing a school district countless dollars in E-rate program 
resources.
---------------------------------------------------------------------------
    \86\ The Mayer Brown Report points out that because these combined 
bids were screened for the lowest lump sum price, the district had no 
guarantee that the E-rate program portion of a particular subcontract 
was being awarded to the lowest bidder for those services. Id. at 29.
---------------------------------------------------------------------------
     The E-rate program offers vendors a powerful incentive to 
sell unnecessary or excessive gear, and to upgrade equipment 
quickly.
    According to the Mayer Brown Report, under the SBC-CPS LAN 
Agreement, SBC agreed to contract directly with contractors to 
perform the construction, installation and related services and 
to be responsible for paying such subcontractors on a timely 
basis. Generally, ``SBC would be compensated by adding a 9.5% 
project management fee to the amounts it paid out to its 
contractors.'' 87 Further, explains the Mayer Brown 
Report, ``given the costly infrastructure that SBC had to put 
in place to manage the project, SBC faced the risk of losing 
money on the contract if CPS failed to authorize a level of 
work sufficient to generate project management fees in excess 
of SBC's costs. The structure of the contract's payment terms 
created an economic incentive for SBC to encourage CPS to spend 
the full amount of any Universal Service Fund award it received 
from SLD.'' 88
---------------------------------------------------------------------------
    \87\ See Mayer Brown Report at 21-22.
    \88\ Id. at 22.
---------------------------------------------------------------------------
    One additional result of this economic incentive was the 
problematic ``refresh'' proposal, described above, involving 
warehoused, new switches that Cisco and SBC described as 
``obsolete.'' While the switches that CPS had purchased only 
months before were no longer ``top of the line'' due to 
technological advances, they were more than adequate for the 
district's governing technology plan at the time. The 
``obsolescence'' to which the vendors referred actually 
described the fact that the equipment possessed a finite date 
beyond which it would not be eligible for vendor maintenance. 
Yet, the switches at issue in Chicago would not reach that 
service life end date for another five years.
    In the end, CPS bought new switches to replace ones that 
had never been installed and which had only been purchased mere 
months before vendors were proposing to replace them. This 
replacement of uninstalled equipment ultimately led to 
unnecessary costs for both the school district and for the E-
rate program. While the proposal included a small trade-in 
rebate on the old switches, CPS would essentially be wasting 
nearly $3.6 million.89
---------------------------------------------------------------------------
    \89\ Id. at 45. While the full refresh plan was never carried out, 
a smaller variation of the refresh went forward. Importantly, however, 
SBC maintains that the SLD had not been billed for the purchase of the 
new switches because CPS never approved the relevant invoices. Id. at 
47.
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E. E-rate Related Investigation of Atlanta Public Schools
    In May 2004, a series of investigative reports by the 
Atlanta Journal-Constitution (AJC) newspaper alleged widespread 
waste, abuse, and mismanagement of more than $60 million in E-
rate program funds by officials at Atlanta Public Schools 
(APS). Subsequently, in June 2004, the Committee began an 
investigation and issued several letters to the district and 
its primary vendors, requesting documents and information 
regarding APS' E-rate program.90 The Committee's 
letters focused on serious allegations that included the 
improper stockpiling of more than $4.5 million in E-rate 
program funded equipment, non-competitive bidding for E-rate 
program work, installation of multiple $100,000 Cisco switches 
in a single school, and other examples of ``gold-plating.'' 
91
---------------------------------------------------------------------------
    \90\ See Committee Letter to Dr. Beverly L. Hall, Atlanta Public 
Schools, dated June 8, 2004.
    \91\ The Subcommittee concluded its investigation without 
determining who was responsible for the decisions regarding the 
installation of these expensive Cisco switches or other gold-plating in 
Atlanta that wasted E-rate program funds. In Chicago, where Staff 
conducted an extensive investigation of CPS' participation in the 
program, Cisco was a prime motivator in the school district's decision 
to install unnecessary switches, as explained, supra, at 35-36.
---------------------------------------------------------------------------
    The Committee also sought details regarding BellSouth's 
installation of an expensive high-capacity network ``backbone'' 
into the district's elementary schools, despite warnings to the 
school board by APS' technology director at the time, that the 
project expansion was unnecessary and proceeding too rapidly. 
On December 19, 2004, a follow-on article by the AJC reported 
that school district officials diverted about $5 million in E-
rate program funds, between 2000 and 2002, to cover the cost of 
unauthorized or ineligible goods and services, including 
consulting fees, plasma television monitors, cell phone bills, 
and wireless Internet access for two of the district's football 
stadiums.
    APS is comprised of 95 schools and approximately 57,000 
students, with 80 of those schools at the E-rate program's 90% 
discount level. During the first four years of the E-rate 
program, $81 million was committed to APS, of which 
approximately $59 million has been disbursed. Additionally, a 
state educational consortium (known as the Metropolitan 
Regional Educational Service Agency, or MRESA) supplied an 
estimated $8 million in E-rate program funded equipment to the 
district during Funding Year 1999. Thus, the district has 
received roughly $68 million in E-rate program funded products 
and services. In Funding Year 2002, APS requested $71 million 
from E-rate, but USAC denied that application because APS 
submitted an E-rate program application that was associated 
with the anti-competitive ``strategic technology partner'' 
application process involving IBM, as described earlier in this 
report.
    A case study of Atlanta Public Schools therefore provided 
an opportunity to examine various dimensions of the 
implementation of E-rate program funded goods and services. 
Subcommittee staff recognized issues relating to competitive 
bidding procedures and the awarding of E-rate program 
contracts, ``gold plating'' schools with unnecessary 
technology, ordering equipment that might never have been 
installed, and funding of equipment that was not ordered. In 
response to the Committee's letter, the school district 
committed itself to providing answers to all of the Committee's 
questions by conducting an internal investigation and 
submitting a comprehensive report on its findings.92 
As a preliminary answer to the requests for documents and 
information, on September 23, 2004, APS provided an ``interim'' 
report 93 to the Committee, prepared by its outside 
counsel, Greenberg Traurig, LLP (``Greenberg'').
---------------------------------------------------------------------------
    \92\ As staff commenced work regarding Atlanta, attempts were made 
to interview several former school officials who were key decision-
makers in APS' E-rate program. Two former leaders of the school 
district's technology department during the relevant time period 
declined, through their respective attorneys, to be interviewed 
regarding APS' participation in the E-rate program. Significantly, the 
respective attorneys for the two technology department officials each 
stated that, unless granted immunity, his client was likely to invoke 
his Fifth Amendment rights if invited to testify at a Committee 
hearing.
    \93\ See Atlanta Public Schools E-rate Program Interim Report by 
Greenberg Traurig, LLP, dated September 23, 2004 (Greenberg Interim 
Report). (The Report is stored at the Committee on Energy and 
Commerce.)
---------------------------------------------------------------------------
    Greenberg submitted an ``interim'' report because the 
school district continued ``to review documents including 
electronic data recovered during the investigation. Also, the 
information contained in this report was not based upon a 
complete audit.'' 94 Further, the interim report was 
submitted without the benefit of adequate interviews of several 
key school officials, and did not answer the Subcommittee's 
Question No. 6, regarding the school district's competitive 
bidding procedures, and Question No. 7(a), regarding any 
circumstances in which ``the school did not receive the 
products and services as specified on E-rate applications or 
invoices.'' 95 Thus, the interim report failed to 
answer critical questions about waste, fraud, and abuse in the 
district's E-rate program.
---------------------------------------------------------------------------
    \94\ Id. at 1.
    \95\ Id. at 6. See also id. at 116-17.
---------------------------------------------------------------------------
    In fact, Greenberg informed Subcommittee staff that APS 
could not produce a complete report without further document 
retrieval and review and that it would cost approximately 
$80,000 to do so. Given the breadth and scope of E-rate program 
waste, fraud, and abuse that the Subcommittee had already 
uncovered and examined elsewhere, it was decided that requiring 
the public school system to incur these additional costs was 
not essential for the Subcommittee to complete its work. Thus, 
before APS submitted a final and complete report, the 
Subcommittee finished its two-year investigation and began the 
work of assembling its findings to assist in laying the 
groundwork for legislation to improve the program. In the 
meantime, APS decided not to proceed with the additional work 
and expense of its internal investigation in connection with 
the Subcommittee's request.
    Moreover, because the Subcommittee ended its E-rate program 
investigation, having accumulated sufficient information 
regarding the program and its weaknesses, staff did not 
continue to further develop information regarding the 
respective roles of the school district and its E-rate program 
vendors in Atlanta. Because this information was not fully 
developed, Subcommittee staff has chosen not to include a 
``findings'' section within this report.
    In February 2005, however, APS issued a press release on 
its Internet website entitled ``National E-rate Investigations 
Not Focused on APS,'' 96 in which it misrepresented 
the outcome of the Subcommittee's work. The school district 
declared that it had conducted an ``exhaustive probe'' and 
provided the Subcommittee with a report and eight boxes of 
documents. The document further stated that ``after reviewing 
the files, Congress took no action against the APS,'' implying 
that the Subcommittee gave APS a clean bill of health regarding 
its participation in the E-rate program.97 As 
previously mentioned, contrary to APS' representations, the 
documents and interim report did not answer all the serious 
questions regarding the school district's management of its E-
rate program. Additionally, the report incorrectly declared 
that APS had ``no documentary evidence'' regarding an 
allegation that vendors had improperly influenced the E-rate 
program application process during Funding Year 2002. In fact, 
the school district had e-mail documents that supported the 
allegation and that at least called for further examination by 
APS.98
---------------------------------------------------------------------------
    \96\ See http://www.atlanta.k12.ga.us/news/goodnews/doc/
022505SoutheastInvestigationOver.pdf
    \97\ On May 6, 2005, the Atlanta Journal-Constitution reported that 
in late April the Justice Department subpoenaed E-rate related records 
from Atlanta Public Schools, for delivery to a federal grand jury by 
May 24, 2005.
    \98\ The report states that investigators could not locate any 
documentary evidence supporting an allegation that an IBM 
representative established a close relationship with Mr. Robert Beman, 
the school district's former Chief Information Officer, and that IBM 
used that relationship to ensure that it had a major role in preparing 
APS' Funding Year 2002 E-rate application through its consultant Alpha 
Telecommunications (``Alpha''). Specifically, an APS employee believed 
that IBM and Alpha had persuaded Mr. Beman to permit Alpha to prepare 
the E-rate forms, to ``assure that IBM received [follow-on] E-rate 
funded contracts . . . in direct response to IBM's alleged 
dissatisfaction about not being awarded APS E-rate funded contracts 
during Funding Year [2001].'' See Greenberg Interim Report at 71-72. 
According to the employee, Mr. Beman ``developed a close relationship 
with IBM, and in particular with IBM's Atlanta representative, Portia 
Lemons.'' Id. at 72. The employee believed that Mr. Beman was urged to 
allow Alpha to prepare the E-rate forms, so that Alpha could ``ensure 
that IBM would be awarded an E-rate funded contract.'' Id. The 
Greenberg Interim Report stated that there was no evidence of such 
communications with Alpha before the application's submission in 
January 2002. However, Alpha produced e-mail documents to the 
Subcommittee that show IBM's and Alpha's interaction with Mr. Beman 
regarding the E-rate program and which support the APS employee's 
account. APS' Funding Year 2002 application was denied because it was 
part of the ``technology integrator'' pattern that was identified by 
USAC as subverting the competitive bid process.
---------------------------------------------------------------------------
F. GAO Work Requested by the Committee
    The Subcommittee has examined various aspects of the E-rate 
program and its impact in several school districts. Through 
this work, a number of troubling failures and weaknesses were 
identified, as outlined in this report. More broadly, the 
failures in preventing waste, fraud, and abuse point to 
problems in the program's structure and the FCC's management of 
the E-rate program.
    In recent years, several initiatives were established to 
address issues of waste, fraud, and abuse in the E-rate 
program. For example, USAC, with the support of FCC, convened a 
14-member Task Force of program ``stakeholders''--comprised of 
vendors, consultants, and school and library officials--to make 
recommendations to reduce waste, fraud, and abuse and improve 
program effectiveness. A number of its recommendations have 
subsequently been addressed in procedural changes or in FCC 
rulemaking.99 Since January 2002, the FCC has 
conducted a series of program rulemakings to address a number 
of issues relating to reducing waste, fraud, and abuse, such as 
strengthening application certifications or bidding 
requirements. While the Subcommittee considers these actions to 
be positive steps, the effectiveness of any given program 
change cannot be assessed until more information is collected 
from audits and the FCC IG's investigations. While the E-rate 
program has evolved, and certainly operates better in some ways 
today than it did in 2001, that evolution has proceeded much 
too slowly. Clearly, not all problems have been addressed by 
these measures. Indeed, the pattern of problems and failures 
involves more fundamental questions about the FCC's management.
---------------------------------------------------------------------------
    \99\ See USAC Memorandum to FCC, dated November 26, 2003. The 
recommendations by the Task Force represented a broad consensus; i.e. 
recommendations were supported by at least 10 Task Force members and 
opposed by no more than two members. Thus, recommendations that might 
have been viewed as affecting too much the interests of vendors (with 
five representatives), would not have been reported.
---------------------------------------------------------------------------
    Thus, with an eye toward gathering further information and 
gaining a better understanding of the FCC's stewardship of the 
E-rate program, then-Chairman Tauzin and then-Subcommittee 
Chairman Greenwood requested that the Government Accountability 
Office (GAO) ``review the E-rate program's structure and 
operations to determine whether federal funds are being used in 
accordance with program rules, whether the funds are being used 
effectively to achieve program goals, and whether the program 
needs fundamental changes to ensure program goals are met.'' 
100 In response to the Committee's request, the GAO 
set out to ``evaluate (1) the effect of the current structure 
of the E-rate program on FCC's management of the program, (2) 
FCC's development and use of performance goals and measures in 
managing the program, and (3) the effectiveness of FCC's 
oversight mechanisms--rulemaking proceedings, beneficiary 
audits, and reviews of USAC decisions (appeals)--in managing 
the program.'' 101
---------------------------------------------------------------------------
    \100\ See http://energycommerce.house.gov/108/Letters/12022003--
1142.htm
    \101\ See ``Telecommunications: Greater Involvement Needed by FCC 
in the Management and Oversight of the E-Rate Program,'' GAO-05-151, 
Feb. 2005 at 3 (hereinafter referred to as the ``GAO Report''); 
Available at http://www.gao.gov/new.items/d05151.pdf.
---------------------------------------------------------------------------
    The completed report, released at a Subcommittee E-rate 
program hearing on March 16, 2005,102 raises serious 
questions about the FCC's management and oversight. The report 
finds an astounding degree of managerial neglect of the E-rate 
program. Due to this neglect, Congress cannot confidently 
assess either: a) the adequacy of the current program 
structure, or b) whether the program is in fact achieving the 
goals contemplated by Congress when it ``created'' the program 
in 1996.
---------------------------------------------------------------------------
    \102\ See ``Hearing on Problems with the E-rate Program: GAO Review 
of FCC Management and Oversight,'' March 16, 2005, Committee on Energy 
and Commerce, Serial No. 109-7.
---------------------------------------------------------------------------
    When Congress codified Universal Service in 1996, it 
effectively changed the nature of the industry-managed 
universal service support from an administratively sanctioned 
process, to a statutorily authorized collection of funds for 
universal service as determined by Congress. The GAO details 
that this action caused the fund to become, essentially, a 
permanent congressional appropriation. Consequently, a key 
series of questions were--or should have been--brought to bear 
on the structure of the fund, the structure of the various 
``funding mechanisms,'' and the entities established to 
administer the fund. It was incumbent upon the FCC, as the 
agency responsible for the fund, to follow the direction of 
Congress concerning universal service. Implicitly, the FCC had 
broader obligations to Congress to ensure the fund's new 
structure adhered to all the relevant statutes, including any 
and all requirements concerning the treatment of appropriated 
funds. This did not happen. As a result, the E-rate program 
from the start has been hampered by lingering questions 
concerning its organization and structure, as mentioned in 
previous GAO reviews of the program.103 Furthermore, 
``new'' questions continue to arise, many of which could have 
been resolved early on in the program.104 The FCC's 
failure to resolve these issues in a comprehensive fashion at 
the outset has led to a number of problems that Congress must 
now address. The GAO report's main findings, with a brief 
Subcommittee staff commentary, include:
---------------------------------------------------------------------------
    \103\ See, e.g., GAO-02-187, February 2002; GAO-01-673, May 2001; 
GAO-01-672, May 2001; GAO-01-105, December 2000; GAO/HEHS-99-133, 
August 1999; RCED-99-51, March 1999; GAO/T-HEHS-98-246, September 1998; 
T-RCED-98-243, July 1998; GAO/RCED/OGC-98-172R, May 1998; GAO/T-RCED/
OGC-98-84, March 1998.
    \104\ For example, in later September and early October 2004, a 
last-minute decision by the FCC regarding the Anti-Deficiency Act's 
(ADA) effects on the E-rate program temporarily prevented USAC from 
issuing commitment letters to E-rate program applicants, until Congress 
passed a temporary exemption of the E-rate program from the ADA.
---------------------------------------------------------------------------
     The FCC crafted an ambitious, multi-billion-dollar 
funding program, using an ``unusual'' organizational structure, 
and then never conducted a comprehensive assessment to 
determine which federal requirements, policies, and practices 
apply to the program, to USAC, and to the Universal Service 
Fund itself.
    This circumstance requires the resolution of several 
structural and fiscal questions to ensure program integrity in 
the future. The GAO notes that USAC--a non-profit, private 
entity--operates and disburses funds under a less explicit 
federal affiliation than many other federal programs. For 
example, USAC and the FCC share no contract or memorandum of 
understanding for administering E-rate. Moreover, USAC is a 
wholly owned subsidiary of another private entity--the National 
Exchange Carriers Association (NECA). This relationship gives 
rise to unanswered questions concerning: (a) the fact that a 
non-governmental entity administers billions of dollars in 
``federal funds''; and (b) the questionable and, by appearance, 
potentially conflicted relationship of USAC and NECA--further, 
while NECA is the sole shareholder of USAC, it is also a major 
subcontractor for USAC that administers part of the 
fund.105 The GAO report provides some details 
regarding the current structure, established by the FCC in 
November 1998 when it appointed USAC the ``permanent'' 
administrator of the program, in an effort to address legal 
concerns raised by the GAO and Congress. Because questions 
remained, the FCC made this appointment subject to a one-year 
review. Significantly, and to some degree emblematic of other 
promises made by the FCC regarding the program, that review was 
never performed. Furthermore, the plan the FCC adopted to make 
USAC the permanent administrator--drafted by the funding 
administrators--recommended full divestiture of USAC from NECA. 
In its 1998 Third Report and Order, the FCC pledged to review 
the divestiture issue after one year, but, again, that review 
never happened. At this point, resolution of these structural 
issues may likely need Congress to provide specific statutory 
guidance.106
---------------------------------------------------------------------------
    \105\ See GAO Report at 70.
    \106\ For example, Congressional guidance may be necessary 
expressly to make USAC the permanent administrator, or to place the E-
rate program within the Executive Branch, or elsewhere. See Third 
Report and Order, FCC 98-306, November 19, 1998.
---------------------------------------------------------------------------
    The nature of the USAC/FCC relationship exacerbates current 
issues concerning the treatment and handling of E-rate program 
funds. The GAO explains that questions about whether Universal 
Service Funds should be treated as ``federal funds''--and thus 
implicating all relevant federal statutes that protect taxpayer 
interests--have plagued the program from the start. The FCC 
failed at the start to determine clearly and comprehensively 
the nature of the funds. Instead, the FCC took a case-by-case 
approach to questions of fund status, and did so with some 
delay. As the GAO notes, this ``put FCC and the program in the 
position of reacting to problems as they occur rather setting 
up an organization and internal controls designed to ensure 
compliance with applicable laws.'' It also raises questions 
about past FCC determinations. Given the piecemeal decision 
making, the GAO states that ``where FCC has determined that 
fiscal controls and policy do apply [to the USF], the 
commission should reconsider these determinations in light of 
the status of universal service monies as federal funds.'' 
107 While the FCC recently began to address some of 
the issues surrounding the funds' status, it has been slow to 
tackle the implications of their status.
---------------------------------------------------------------------------
    \107\ See GAO Report at 66-68.
---------------------------------------------------------------------------
    Indeed, the FCC's hesitation has caused unnecessary 
disruptions and waste in E-rate program operations. For 
example, on September 26, 2003--more than five years into the 
E-rate program--the FCC mandated that USAC prepare USF 
financial statements consistent with ``generally accepted 
accounting principles for federal agencies' (GovGAPP). The FCC 
expressly noted that this change could have broad implications 
regarding compliance with a myriad of federal accounting 
statutes, and therefore gave USAC one year to transition to 
GovGAPP. But the FCC subsequently failed to review in a timely 
manner the change's implications and provide the necessary 
guidance to USAC. Ultimately, the FCC's delay led to USAC 
suspending E-rate program commitments in August 2004 until the 
FCC responded to USAC's query as to whether the Anti-Deficiency 
Act applied to E-rate program funds. The FCC did not address 
the issue until two weeks before the deadline for the GovGAPP 
standards to take effect. As a result of the FCC's actions, the 
USF lost approximately $4.6 million. Additionally, the delay 
froze hundreds of millions of dollars in E-rate program 
commitment decisions, thus postponing and disrupting the 
planning at school districts around the nation. As this report 
noted earlier, funding delays by the FCC and USAC conflict with 
school districts' budgeting and planning cycles and thus 
increase the risk of waste and abuse.
    The GAO report confirms that Universal Service Funds should 
be treated as federal funds, and that all applicable federal 
statutes and requirements apply to the administration of the 
USF, unless specifically exempted by Congress. What remains 
unclear, however, is the extent to which such requirements will 
affect USAC and the Fund. For example, how do relevant statutes 
such as the Single Audit Act, the Cash Management Improvement 
Act, and the Improper Payments Information Act of 2002 impact 
E-rate program funds? Furthermore, absent a comprehensive 
review and assessment, poorly founded decisions may be made 
about Fund treatment, to the detriment of the 
taxpayers.108
---------------------------------------------------------------------------
    \108\ A bill has been introduced in the Senate, S. 241, that 
exempts the Universal Service Fund from the Anti-Deficiency Act. Absent 
careful study, any exemptions from federal accounting statutes may be 
premature and may do more harm than good.
---------------------------------------------------------------------------
     Although USAC has committed more than $15 billion to E-
rate program applicants during the past 8 years, the FCC did 
not develop performance goals and measures that could be used 
to assess the specific impact of this spending and to improve 
the management of the program.109
---------------------------------------------------------------------------
    \109\ According to USAC data, as of October 5, 2005, it has 
committed over $15 billion and actually disbursed more than $10 billion 
in E-rate program funds.
---------------------------------------------------------------------------
    The FCC, USAC, E-rate program participants, and observers 
of the E-rate program have frequently noted that, since the 
program began in 1998, the nation's schools have significantly 
increased their rates of Internet access and connectivity. The 
Department of Education's National Center for Education 
Statistics are frequently cited--which report that, as of 2003, 
100% of public schools and 93% of public school instructional 
classrooms had Internet access, up from 89% and 51%, 
respectively, in 1998.110 While this information may 
be valuable to a broader assessment of the nation's 
telecommunications and education policies, it does not provide 
or represent a meaningful measure of the E-rate program's 
impact. The GAO notes that ``although billions of dollars of E-
rate funds have been committed since 1998, adequate program 
data was not developed to answer a fundamental performance 
question: how much of the increase since 1998 in public 
schools' Internet access has been a result of the E-rate 
program, as opposed to other sources of federal, state, local, 
and private funding?'' 111
---------------------------------------------------------------------------
    \110\ See ``Internet Access in U.S. Public Schools and Classrooms: 
1994-2003,'' National Center for Education Statistics, February 2005 at 
3-7, 18-23.
    \111\ See GAO Report at 21-22.
---------------------------------------------------------------------------
    The failure to implement performance measures bears on a 
number of aspects of the FCC's E-rate program management, in 
addition to the fact that it ignores requirements of the 
Government Performance Results Act of 1993. Perhaps most 
troubling, Congress has little or no information about the 
program's effectiveness; yet, more than $9 billion has been 
spent. This does not mean that the program has not been 
effective--the Subcommittee's investigation has observed 
compelling examples of E-rate program funding being used to 
improve classroom instruction and the coordination of effective 
instruction. However, the FCC has squandered the opportunity to 
quantify and assess--and ultimately, to improve--the program's 
effectiveness and efficiency in a meaningful way. This is a 
profound failure in the FCC's responsibility and accountability 
to Congress, which in the end must answer to American taxpayers 
about the value and direction of the E-rate program.
    The failure to institute performance measures is 
symptomatic of the broader management problems at the FCC 
concerning the E-rate program. In the past, the FCC has 
informed the GAO that it would implement performance goals and 
plans for the E-rate program, but then failed to do so. For 
example, in December 2000 the FCC told the GAO that it had 
finalized a new performance plan to increase the rate of 
program participation by low-income, urban schools. Yet, the 
current GAO report notes that when it inquired in 2004 about 
the plan, ``we were told that it had not been implemented and 
that none of the FCC staff currently working on E-rate was 
familiar with the plan.'' 112 Staff turnover, as 
well as the size of the staff overseeing the USF,113 
contributes to this lack of institutional follow-through and 
the general ability to address program issues and policy 
questions in a timely manner, see below. Instances such as this 
undercut confidence in the FCC's promises to address these 
issues and increase its attention to the program.
---------------------------------------------------------------------------
    \112\ Id. at 23.
    \113\ Id. at 57.
---------------------------------------------------------------------------
     The FCC's three key oversight mechanisms for the E-rate 
program--rulemaking procedures, beneficiary audits, and reviews 
of USAC decisions (appeals decisions)--are not fully effective 
to manage the program.
    This GAO finding highlights a number of observations and 
problems identified by the Subcommittee during the course of 
the investigation. However potentially effective these three 
oversight mechanisms may be for a regulatory agency, the record 
suggests that they fall short in effectively managing a large, 
complicated, quasi-grant program like E-rate. These mechanisms 
are even less effective because of the FCC's evident 
inattention to the program.
    The management and oversight issues identified by the GAO 
include:
    (1) The FCC is currently relying on USAC to identify which 
procedures should be codified into rules, raising the question 
of which ``entity is really establishing the rules of the 
program and--concerns about the depth of involvement by FCC 
staff with the management of the program.'' 114
---------------------------------------------------------------------------
    \114\ Id. at 29.
---------------------------------------------------------------------------
    (2) The FCC has not fully addressed confusion and 
enforcement issues arising from the distinction between USAC 
``implementing procedures'' and the FCC's program rules. This 
causes confusion regarding rule enforcement and the ability to 
recover funds when USAC procedures are violated. The GAO notes, 
for example, that, even under the FCC's August 2004 Fifth 
Report and Order, which addressed some questions concerning 
codifying procedures, ``the commission did not clearly address 
the treatment of beneficiaries who violate a USAC 
administrative procedure that has not been codified.'' The GAO 
explains that this ``creates a potentially unfair situation 
when the procedure is one that can lead to denial of an 
application.'' That is, if a procedure violation is caught in 
the application process, funding will be denied; if it is 
caught later, in a beneficiary audit, no action to recover 
funds can be taken.115
---------------------------------------------------------------------------
    \115\ Id. at 27-30.
---------------------------------------------------------------------------
    (3) The FCC resolves appeals too slowly, and has a very 
large backlog of appeals--527 appeals were pending decisions at 
the time the GAO completed its review. This adds uncertainty to 
the program and leaves applicants in an E-rate program 
``limbo,'' and raises the risk of both wasted funding 
opportunities and wasteful spending. All of these examples 
raise questions about the FCC's ability to handle the 
additional burden of audit resolution that is expected to arise 
from a new set of about 200 beneficiary audits planned for the 
program. Resource demands are only likely to grow, and it is 
not clear that the FCC will be able to keep up. In short, the 
GAO concludes, the FCC simply has not done enough to manage and 
provide a framework of government accountability for the multi-
billion-dollar E-rate program. The prospects for positive 
progress in the future, given the FCC's past actions, staff 
turnover, and neglect, are not encouraging.
    GAO Recommendations: The GAO concluded that the problems it 
identified signal that the FCC must take corrective action. The 
GAO report recommended that the Chairman of the FCC direct the 
agency to take the following actions:

1. Conduct and document a comprehensive assessment to determine 
        whether all necessary government accountability 
        requirements, policies, and practices have been applied 
        and are fully in place to protect the program and the 
        funding. The assessment should include, but not be 
        limited to: (a) the implications of the FCC's 
        determination that the Universal Service Fund amounts 
        to an ``appropriation'' by identifying the fiscal 
        controls that apply to the Universal Service Fund, 
        including the collection, deposit, obligation, and 
        disbursement of funds; and (b) an evaluation of the 
        legal authority for the organizational structure of the 
        E-rate program, including the relationship between the 
        FCC and USAC and their respective authorities and roles 
        in implementing the E-rate program.116
---------------------------------------------------------------------------
    \116\ In connection with the GAO work and Subcommittee inquiry, the 
FCC announced in March 2005 that it had contracted with the National 
Academy of Public Administration (NAPA) for NAPA to study and explore 
alternative models to the current organizational and government 
structure of the Universal Service program. The GAO testified before 
the Subcommittee on March 16, 2005 that this study would go ``a long 
way toward addressing the concerns'' on this issue outlined in its 
report. However, at an April 26, 2005 House Appropriations Justice 
State Subcommittee hearing, FCC Chairman Martin testified that the 
study had been put on hold pending further review. On June 9, 2005 the 
FCC issued a Notice of Proposed Rulemaking and Further Notice of 
Proposed Rulemaking to initiate ``a broad inquiry into the management 
and administration of the Universal Service Fund.'' Because of this 
action, Chairman Martin cancelled the NAPA contract. Staff believes the 
FCC's decisions on this front will demonstrate the depth of the 
agency's seriousness in implementing the GAO's recommended reforms.
---------------------------------------------------------------------------
2. Establish performance goals and measures for the E-rate 
        program that are consistent with the Government 
        Performance and Results Act. The FCC should use the 
        resulting performance data to develop analyses of the 
        actual impact of E-rate program funding and to 
        determine areas for improved program operations.
3. Develop a strategy for reducing the E-rate program's 
        backlog, including ensuring that adequate staffing 
        resources are devoted to E-rate program appeals 
        resolution.
    The staff concurs with these recommendations. They are 
reasonable and necessary steps that the FCC must take to begin 
resolving the problems identified both by this Subcommittee, 
the FCC IG, and the GAO. Each of the recommendations addresses 
the main findings in the GAO report. Further, as the GAO 
recommends, the FCC should request of the Comptroller General 
an advance decision, as applicable under 31 U.S.C  3529, on 
matters relating to the complexities posed by the FCC's 
arrangements with USAC and the questions that flow from these 
arrangements.
    Given the FCC's history of E-rate program management, as 
identified by the GAO and this Subcommittee's investigation, 
the FCC should produce for the Committee a report with relevant 
findings and actions, addressing the GAO's recommendations. The 
FCC's analysis should recognize the dynamic state of 
technology, and offer an assessment of the extent that, given 
the data that 100% of schools are reportedly connected to the 
Internet, the emphasis of the E-rate program's non-Priority I 
funding may well shift to upgrades and maintenance. Given the 
current state of Internet connectivity, measurement and goals 
matrices for assessing program progress that may have been 
appropriate for 1998 may no longer be valid for 2006 and 
beyond. The FCC should account for the current state of school 
technology in its analyses.
    The staff agrees with the GAO's view that any reassessment 
of the program must consider the needs of the beneficiaries--
the schools and libraries across the country that use the E-
rate program to support their purchase of telecommunications 
services. Efforts to protect the program from waste, fraud, and 
abuse do not need to be mutually exclusive of a program that 
does not excessively burden the participants. This may first 
require an honest assessment of the program's goals and 
operations. Additional assistance from the GAO to review and 
assess crosscutting efforts by other Federal agencies to assist 
schools and school districts is probably necessary to develop 
an accurate picture of federal support of telecommunications in 
education.

                                 
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